Incomplete Contracts as a Screening Device in Competing Vertical Inter-Firm Relationships

Recent research in industrial organization has emphasized the strategic value of incomplete contracts in vertical inter-firm relationships. This paper offers a screening rationale for contractual incompleteness in a class of producer-retailer economies when countervailing incentives arise. By means of a simple agency model, we show that, when the agent (retailer) operates in an imperfectly competitive market, the principal (producer) may deliberately choose to exploit incomplete contracts to warrant truthful revelation of the retailer’s private information. While the contractual provision of monitoring instruments to prevent agent’s misbehavior may well fail to induce self-selection, full separation always obtains under incomplete contracts in the presence of countervailing incentives.