№ XV
The twelve plates
A contract is how a promise becomes an obligation — how strangers convert a hope into a claim a court will honor. But no contract can foresee everything, and so every contract is incomplete, riddled with gaps where the unforeseen will fall. This volume anatomizes the deal and its unfinished nature: the gaps no clause can close, the residual power that fills them, the agent and the principal, and the trust, reputation, and discretion that hold a relationship together where the written word runs out.
no contract can foresee everything, and so every agreement is unfinished — but if the words always run out before the world does, what governs a relationship in the gaps they leave: the terms the parties wrote, or the power that fills the silence between them?
A contract is a promise the law will keep for you. It is the instrument by which two parties who may not trust each other, and may never meet again, can nonetheless cooperate: each binds himself to do his part, and the binding is enforceable, so that a hope becomes an obligation and a handshake a claim a court will honor. Without it, exchange across time would be impossible — no one would deliver today against a promise to pay tomorrow, no one would build to another's order or lend against another's word — and so the contract is among the deepest of economic institutions, the one that lets a market reach beyond the simultaneous swap of goods in hand into the vast web of deferred and conditional dealings on which a modern economy runs. It is, in a phrase, the institution of the deal: the device that turns the future into something one can buy and sell.
But the contract carries a flaw in its very nature, and the flaw is the subject of this volume. A contract must be written before the future it governs has arrived, and the future is more various than any drafter can foresee. The contingencies that might bear on a deal are without number; language is too coarse to capture them all; and the human mind, as Herbert Simon insisted against the fiction of perfect rationality, is boundedly rational — able to attend to only a few of the possibilities the world holds in store. Even were foresight perfect, the cost of writing every contingency into the text, and of haggling over each, would swallow the gains the deal was struck to capture. So no contract specifies everything. Every contract, however long and however lawyered, is shot through with gaps — silences where the unforeseen will one day fall, and the words simply run out.
These gaps are not the mark of careless drafting; they are the permanent and inescapable condition of agreement. The complete contract — the document that anticipates every state of the world and assigns to each its precise obligation — is an economist's fiction, useful for a theorem and impossible in life. Every real contract is a sketch, setting down the main lines of the bargain and trusting to something outside the text to fill the rest. Ronald Coase built the modern theory of the firm on the recognition that contracting is costly — that the very expense of writing and enforcing market agreements is what drives activity inside the firm, where direction replaces negotiation — and Oliver Williamson made a science of the matter, showing how the hazards of incomplete contracts, where parties have sunk investments specific to a relationship, shape the institutions of governance that grow up around the deal. The gap, in short, is where the economics of organization begins: the complete contract would need no firm, no court, no trust, and no governance at all.
What, then, fills the gap? When the unforeseen arrives and the contract is silent, someone must decide what is to be done — and the party who holds the right to decide what the contract did not specify holds the real power in the relationship. Economists call this residual control, and Oliver Hart, with Sanford Grossman and John Moore, built upon it a theory of ownership itself: to own an asset, in their account, is precisely to hold the residual right to determine its use in all the circumstances the contract left open. The owner of the factory decides what the agreement with the supplier did not; the employer directs the worker in all the particulars the wage contract could not name. Possession of the residual right is possession of the power to fill the silences to one's own advantage, case by unforeseen case — and so the allocation of that right, far more than the explicit terms, decides who will fare well when the world does something the contract did not foresee.
And here the contract reveals what it shares with every figure this work has examined. The written agreement presents itself as complete and settled: the terms are fixed, the price is named, the deal is done, and the parties have, in the law's old phrase, a meeting of minds. But beneath the written terms lies the unwritten remainder, and the remainder is governed not by agreement but by power — by who holds the residual control, who has the better outside option, who can walk away from the relationship and who cannot. A price is a verdict on a hidden contest, mistaken for a fact of nature; and the price a contract names is a verdict of exactly that kind, the visible settlement of a bargain whose unwritten remainder is contested still. What looks like a complete specification of the parties' obligations is a sketch over a silence, and the silence is filled by the distribution of power between them.
The point goes deeper than drafting. The written contract is the visible tip of the relationship; the submerged mass — the discretion exercised when the text is silent, the trust that performance will be forthcoming, the reputation each party stakes, the threat of exit each holds in reserve — is what actually governs the dealing, and none of it is in the words. The principal cannot fully watch the agent who acts in his name, and must trust or incentivize what he cannot compel; parties who have sunk their investments into a relationship are exposed to being held up when the terms are reopened; the long bargains that sustain commerce are kept less by the contract than by the relationship around it, as Stewart Macaulay found when he discovered how rarely businessmen consult the documents they sign. A price is a verdict on a hidden contest, mistaken for a fact of nature; and the meeting of minds the law speaks of is, wherever the contract falls silent, a meeting of wills, its outcome decided by the same distribution of power that decides every other price.
Yet to say that the contract is incomplete is not to say that it fails, for around the gap a whole apparatus of gap-filling has grown up, and it is the achievement of the institution that the silences are, for the most part, well filled. Where the contract is silent, the law supplies a default — a term the parties are presumed to have wanted, or one designed to prod them into speaking — and the court stands ready to construe what they did not write. Reputation disciplines the party tempted to exploit a gap, for a name for sharp dealing is dear in a world of repeated business; trust, built over years, lets partners leave much unsaid in confidence it will be honored; and the careful allocation of ownership and authority places the residual power where it will do the least harm. The contract works not in spite of its incompleteness but through the institutions that manage it — and the study of the deal is, in the end, the study of how a necessarily unfinished agreement is nonetheless made to hold.
The twelve plates follow the contract from the gap that opens in it to the promise that would close it. They set out the gap itself — the incompleteness no clause can cure — and the remainder, the residual power that fills it; the deputy who acts for a principal he may not faithfully serve, and the spur of incentive by which the principal tries to align him; the pledge that makes a promise credible where the law cannot compel it, and the word, the trust and reputation that bind a relationship beyond its text; the holdup that threatens whoever has sunk an investment the other can exploit, and the default the law supplies when the parties have said nothing; the form, the take-it-or-leave-it bargain whose fine print no one reads, and the breach, the broken promise and the price the law sets on breaking it; the discretion an employer buys with a wage, the authority to direct; and, at the last, the promise itself — whether any words can truly bind a future neither party can foresee. Other volumes have prepared the ground: the volume on the firm traced the authority that supplants the market where contracting fails; that on the asymmetry, the hidden action and hidden knowledge that make the agent so hard to bind; on the money, the promise to pay that is itself a kind of contract; on the wage, the employment bargain whose terms the contract cannot wholly fix. The contract takes its place among the institutions as the one that binds the future — and finds, in every gap it cannot close, the contest of power it was meant to settle. The argument remains open.