Contract Theory

Bolton and Dewatripont wrote the standard graduate textbook on contract theory, covering the formal analysis of agreements between parties with different information and conflicting interests.

The coverage follows the field's structure. Adverse selection covers situations where one party has private information before contracting, and the analysis produces screening contracts, the revelation principle and the efficiency losses that information rents impose. Moral hazard covers situations where actions are unobservable after contracting, producing the trade-off between incentive provision and risk sharing, the multitask problem where effort has several dimensions and only some are measurable, and career concerns models. Incomplete contracts covers situations where the parties cannot specify all future contingencies, producing the property rights theory of the firm developed by Grossman, Hart and Moore, and the hold-up problem that explains vertical integration. Later chapters cover repeated relationships, renegotiation, mechanism design and applications to corporate finance, including debt as a contract that allocates control contingent on performance.

The book is mathematical and is written for doctoral students. It is a reference rather than a book to read through.

For investors and operators the relevance is indirect but real: the results explain why performance pay distorts multitask jobs, why ownership matters when contracts cannot cover everything, why debt covenants transfer control rather than merely protect value, and why some transactions must be brought inside a firm. Readers wanting those conclusions without the mathematics should use Milgrom and Roberts instead. The field has developed since 2005, particularly on relational and behavioural contracting.