In negotiations in which the potential value creation depends upon external uncertainties, and the players have different beliefs about these uncertainties, it is well known that contingent contracts can enable agreement. But by allowing contingent payments, each player’s expected value capture can, in some situations, be made arbitrarily large. This fact prompts two natural questions. Does the increase in the players’ expected value capture imply an increase in expected value creation? And is there a point at which the contract can become more about making a wager and less about exploiting differences to enable agreement? We address these questions by showing that a player’s expected value capture can be separated into two components: an expected share of ex post value creation and an expected transfer of value from one player to another. The latter can be represented by a zero-sum wager. We show that if contracts are restricted to be ex post individually rational—a natural condition implicit in Arrow (1953) and Raiffa (The art & science of negotiation, Harvard University Press, Cambridge, 1982)—a joint increase in the players’ expected value captures can always be attributed to a division of ex post value creation that better exploits the players’ beliefs rather than to an increase in an embedded zero-sum wager.
This is a preview of subscription content, access via your institution.
Buy single article
Instant access to the full article PDF.
Price includes VAT (USA)
Tax calculation will be finalised during checkout.
Note that by assuming risk neutrality, there will be no value created through risk sharing.
Bazerman and Gillespie (1999) specifically mention the need for ‘enforceability’ and provide the advice, ‘Don’t bet if you can’t collect.’
We are assuming that the players take no pleasure in betting for the sake of betting.
Arrow KJ (1953) Le Role des Valeurs Boursieres pour la Repartition la Meilleure des Risques. International Colloquium on Econometrics, 1952, Centre National de la Recherche Scientifique, Paris (1953) Translated as The role of securities in the optimal allocation of risk-bearing. Review of Economic Studies 31, 1964
Aumann R (1976) Agreeing to disagree. Ann Stat 4:1236–1239
Bazerman MH, Gillespie JJ (1999) Betting on the future: the virtues of contingent contracts. Harv Bus Rev 77(5):155–160
Brunnermeier MK, Simsek A, Xiong W (2014) A welfare criterion for models with distorted beliefs. Q J Econ 129(4):1753–1797
Forges F, Minelli E, Vohra R (2002) Incentives and the core of an exchange economy: a survey. J Math Econ 38:1–41
Gayer G, Gilboa I, Samuelson L, Schmeilder D (2014) Pareto efficiency with different beliefs. J Leg Stud 43:S151–S171
Gilboa I, Samuelson L, Schmeilder D (2014) No-Betting-Pareto Dominance. Econometrica 82(4):1405–1442
Holmström B, Myerson RB (1983) Efficient and durable rules with incomplete information. Econometrica 51(6):1799–1819
Kay J (2015) Other people’s money: the real business of finance. PublicAffairs, New York
Lax DA, Sebenius JK (1986) The manager as negotiator: bargaining for cooperation and competitive gain. Free Press, New York
Radner R (1968) Competitive equlibrium under uncertainty. Econometrica 36(1):31–58
Raiffa H (1982) The art & science of negotiation. Harvard University Press, Cambridge
The author thanks Patrick Bolton, Fangruo Chen, Patrick Sileo, and George Wu for many helpful discussions about this paper. The author also thanks two anonymous referees for paper-improving suggestions. Financial support from Columbia Business School is gratefully acknowledged. This paper is dedicated to the memory of Howard Raiffa.
About this article
Cite this article
Stuart, H.W. Contingent Contracts and Value Creation. Group Decis Negot 26, 815–827 (2017). https://doi.org/10.1007/s10726-016-9522-6
- Contingent contract
- Value creation
- Ex post rationality