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. Game Theory

    A model of optimality taking into consideration not only benefits ...
  2. Transparency

    The extent to which investors have ready access to any required ...
  3. Disclosure

    The act of releasing all relevant information pertaining to a ...
  4. Asymmetric Information

    A situation in which one party in a transaction has more or superior ...
  5. Moral Hazard

    The risk that a party to a transaction has not entered into the ...
  6. Insider Information

    A non-public fact regarding the plans or condition of a publicly ...
Related Articles
  1. Economics

    When The Federal Reserve Intervenes (And Why)

    The Federal Reserve doesn't interfere with the economy every time it flounders. Find out more here.
  2. Options & Futures

    Game Theory: Beyond The Basics

    Take your game theory knowledge to the next level by learning about simultaneous games and the Nash Equilibrium.
  3. Options & Futures

    Moral Hazards: A Bump In The Contract Road

    Learn how this phenomenon can cause a party in an agreement to behave differently than expected.
  4. Fundamental Analysis

    The Basics Of Game Theory

    Break down and examine the potential consequences of economic/financial scenarios.
  5. Investing Basics

    What is the effect of price inelasticity on demand?

    Find out why price inelasticity of demand shows the relationship between demand and price if the price of an inelastic good is either lowered or raised.
  6. Options & Futures

    What is the difference between inelasticity and elasticity of demand?

    Find out how elasticity of demand and inelasticity of demand are two sides of the same coin, based on the calculated elasticity quotient.
  7. Economics

    Will the consumer price index (CPI) be updated or revised in the future?

    Learn about the consumer price index (CPI) and understand how its purpose and calculation make it necessary to continually update and revise it.
  8. Economics

    Does the consumer price index (CPI) correlate with the change in price of goods and services?

    See why the consumer price index is a questionable proxy for inflation, and why it is unlikely to represent experiences with price changes accurately.
  9. Personal Finance

    Do minimum wage laws make labor a fixed or variable cost?

    Find out why labor is a classified as a semi-variable cost by the minimum wage laws; labor has elements of both fixed costs and variable costs.
  10. Economics

    Is the consumer price index (CPI) a cost of living index?

    Explore the consumer price index (CPI) and understand why it is not an actual cost of living index although it is often identified as one.

You May Also Like

Hot Definitions
  1. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  2. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  3. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  4. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  5. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
  6. Federal Funds Rate

    The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution ...
Trading Center