Contract Theory

AAA

DEFINITION of 'Contract Theory'

The study of how individuals and businesses construct and develop legal agreements. Contract theory analyzes how parties to a contract make decisions under uncertain conditions, and when there is asymmetric information. It draws upon principles of financial and economic behavior, as principles and agents often have different incentives to perform or not perform actions.

INVESTOPEDIA EXPLAINS 'Contract Theory'

Contract theory is closely related to game theory, which looks at the decision-making process followed by individuals and businesses. Contracts can be incentivized in order to promote certain outcomes, but can also contain a level of moral hazard stemming from the distance between the principle and agent.

RELATED TERMS
  1. Asymmetric Information

    A situation in which one party in a transaction has more or superior ...
  2. Game Theory

    A model of optimality taking into consideration not only benefits ...
  3. Insider Information

    A non-public fact regarding the plans or condition of a publicly ...
  4. Moral Hazard

    The risk that a party to a transaction has not entered into the ...
  5. Disclosure

    The act of releasing all relevant information pertaining to a ...
  6. Transparency

    The extent to which investors have ready access to any required ...
Related Articles
  1. When The Federal Reserve Intervenes ...
    Economics

    When The Federal Reserve Intervenes ...

  2. Game Theory: Beyond The Basics
    Options & Futures

    Game Theory: Beyond The Basics

  3. Moral Hazards: A Bump In The Contract ...
    Options & Futures

    Moral Hazards: A Bump In The Contract ...

  4. The Basics Of Game Theory
    Fundamental Analysis

    The Basics Of Game Theory

comments powered by Disqus
Hot Definitions
  1. Takeover

    A corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the ...
  2. Harvest Strategy

    A strategy in which investment in a particular line of business is reduced or eliminated because the revenue brought in by ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Pareto Principle

    A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The ...
  5. Pareto Principle

    A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The ...
  6. Budget Deficit

    A status of financial health in which expenditures exceed revenue. The term "budget deficit" is most commonly used to refer ...
Trading Center