Limited Attention and the Optimal Incompleteness of Contracts.

A decision-maker's limited attention is allocated between writing new contracts and directing current contracts. More time spent writing a new contract makes the contract more complete. A more complete contract performs better and generates higher returns. The optimal allocation of attention implies two types of contracts, relational and market. A relational contract, which is directed periodically, is optimally less complete than a market contract, which is not directed. The completeness of relational contracts decreases with the ability to direct contracts, since changing circumstances can be dealt with later. In addition, the completeness of relational contracts increases with the ability to write new contracts, since more complete relational contracts are directed less frequently and leave more time for writing new contracts. The optimal allocation of attention to relational contracts is socially efficient even though it does not maximize the discounted expected returns of the firm. Copyright 1999 by Oxford University Press.