This is an accomplishment-based renewal of research by one of the architects and leading contributors to the incomplete contracts paradigm for analyzing economic decisions under incomplete information. The key feature of this approach is that it incorporates transaction costs inherent in the writing of long- term contracts (for example, thinking, negotiation, writing and enforcement costs). Because of these transaction costs parties will write contracts that are incomplete ex-ante, knowing that these contracts will be renegotiated later on as new information comes in. The approach studies how this renegotiation takes place and what implications it has for agents' incentives to take various ex-ante actions. Under the previous NSF grant the investigator made important contributions in three areas: the theory of the firm, vertical integration and market foreclosure, and the financial structure of the firm. Continued support will lead to further advances in our understanding of the nature of business internal organization and financial structure. This grant continues work on contract and control issues in firms and corporations. It provides a better understanding of what determines the structure of claims in corporations and the various rights possessed by claim-holders, e.g., why debt has priority over equity, creditors have the right to liquidate assets in the event of default and equity-holders have votes. One especially interesting paper in this line of research will be a study of what lessons the emerging Eastern European democracies can learn from the Western experience with different bankruptcy procedures. The project will also continue to study how transactions within firms differ from those between firms, and what are the motives for integration by firms.
