We present a formal treatment of contracting in the face of ambiguity. The central idea is that boundedly rational individuals will not always interpret the same situation in the same way. More specifically, even with well defined contracts, the precise actions to be taken by each party to the contract might be disputable. Taking this potential for dispute into account, we analyze the efects of ambiguity on contracting. We find that risk averse agents will engage in ambiguous contracts for risk sharing reasons. In addition to the risk sharing motivations for contracting in the presence of ambiguity, we find that agents may contract in order to reduce the downside efects of non-cooperative opportunism arising from ambiguity.
Available at: http://works.bepress.com/jeffrey_kline/13/