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. Asymmetric Information

    A situation in which one party in a transaction has more or superior ...
  4. Insider Information

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

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

    The act of releasing all relevant information pertaining to a ...
RELATED FAQS
  1. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  2. What does marginal utility tell us about consumer choice?

    In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction ... Read Full Answer >>
  3. What is the difference between JIT (just in time) and CMI (customer managed inventory)?

    Just-in-time (JIT) inventory management focuses solely on the need to replenish inventory only when it is required, reducing ... Read Full Answer >>
  4. What are some examples of Apple and Google's best-selling product lines?

    There are many good examples of product lines in the technology sector from some of the largest companies in the world, such ... Read Full Answer >>
  5. What is a negative write-off?

    A negative write-off is a write-off conducted by a company or accountant after deciding not to pay back an individual or ... Read Full Answer >>
  6. How can tariffs cause inefficiencies in domestic industries?

    Any government regulation naturally creates inefficiencies in a pure supply and demand marketplace. When it comes to the ... Read Full Answer >>
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. Stock Analysis

    The Top Performing Airlines Right Now

    Learn about the airline industry and its top-performing companies. Understand these top-emerging airlines and why they have taken more market share.
  6. Economics

    Understanding the Product Life Cycle

    Product life cycle is the period of time during which a product is conceived and developed, brought to market and eventually removed from the market.
  7. Economics

    What's a Centrally Planned Economy?

    A centrally planned economy is one where the government controls the country’s supply and demand of goods and services.
  8. Economics

    What are Barriers to Entry?

    A barrier to entry is any obstacle that restricts or impedes a company’s efforts to enter an industry.
  9. Economics

    Explaining Aggregate Supply

    Aggregate supply is the total supply of goods and services an economy produces in a given time period.
  10. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P 500 Trust

    Find out more about the SPDR S&P 500 ETF Trust, the characteristics of the exchange traded fund and the suitability of investing in the fund.

You May Also Like

Hot Definitions
  1. Dog And Pony Show

    A colloquial term that generally refers to a presentation or seminar to market new products or services to potential buyers.
  2. Topless Meeting

    A meeting in which participants are not allowed to use laptops. A topless meeting organizer can also ban the use of smartphones, ...
  3. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  4. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  5. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  6. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!