.Econometrica, Vol. 67, No. 4 July, 1999 , 741781INCOMPLETE CONTRACTS: WHERE DO WE STAND?1BYJEANTIROLE2The paper takes stock of the advances and directions for research on the incompletecontracting front. It first illustrates some of the main ideas of the incomplete contract literature through an example. It then offers methodological insights on the standard approach to modeling incomplete contracts; in particular it discusses a tension between two assumptions made in the literature, namely rationality and the existence of transac- tion costs. Last, it argues that, contrary to what is commonly argued, the complete contract methodology need not be unable to account for standard institutions such as authority and ownership; and it concludes with a discussion of the research agenda.KEYWORDS: Incomplete contracts, unforeseen contingencies, authority, transaction costs.1.INTRODUCTIONTHE PURPOSE OF THIS PAPERis to take stock of the advances and directions for research on the incomplete contracting front.3It emphasizes methodological issues over questions about the economic relevance of incomplete contract models. Incomplete contracting arguably underlies some of the most important questions in economics and some other social sciences, and unquestionably has been left largely unexplored and poorly understood. A methodological divide may have developed in our profession in recent years between those who advocate pragmatism and build simple models to capture aspects of reality, and others who wonder about the foundations and robustness of these models, and are concerned by the absence of a modeling consensus similar to the one that developed around the moral hazard and adverse selection paradigms in the 70s. .I personally have sympathy for both viewpoints. Almost every economist would agree that actual contracts are or appear quite incomplete. Many contracts are vague or silent on a number of key features. A1WalrasBowley lecture delivered at the 1994 North American Summer Meetings of the Econo-metric Society in Quebec City. 2This paper could not have been written without the intellectual stimulus of several researcherswith whom I have been fortunate to collaborate. It builds on key insights due to Oliver Hart onincomplete contracts and to Eric Maskin on implementation. I have also benefited much from working on the topic of the lecture with Philippe Aghion, Mathias Dewatripont, Bengt Holmstrom, and JeanJacques Laffont. I am very indebted to JeanJacques Laffont and Eric Maskin for their substantial input in the preparation of the paper. I am also grateful to Philippe Aghion, Bernard Caillaud, Oliver Hart, Martin Hellwig, Bruno Jullien, Bentley MacLeod, Eric Rasmussen, Patrick Rey, Steve Tadelis, a co-editor, and three referees for helpful comments. 3.Ten years have elapsed since Oliver Harts FisherSchultz lecture on the topic see Hart 1989 , .and twelve years since his and Bengt Holmstroms 1987 World Congress survey of contract theory, which also touched on incomplete contracting. There has since been much activity in the area,including significant work by these two authors.741JEAN TIROLE742case in point is the organization of political life. In the executive, ministries and agencies are given loose objectives, such as promoting the long-range security .and well-being of the United StatesUS Department of State , fostering, promoting and developing the welfare of the wage earners of the United States .US Department of Labor , or as establishing just and reasonable rates for .electricity or telephone Public Utility Commission . No mention is made of the many contingencies that may determine the ministrys desirable choices and of how decisions are to react to these contingencies. Similarly, the legislative branch of the government is set up as a distribution of agenda setting powers, voting rights, and checks and balances between houses rather than as a contract specifying how public decisions follow from the elicitation of information aboutthe economy and the society. Indeed, I would argue that the difficulties encoun- tered in conceptualizing and modeling incomplete contracting partly explain why the normative agenda of the eighteenth century political scientistsnamely addressing the question of how one should structure political institutionshas made little progress in the last two centuries.4 Incomplete contracting is argued to be the key to a good understanding of a number of economic issues as well. Consider the patent system. It has long beenrecognized that patents are an inefficient method for providing incentives for innovation since they confer monopoly power on their holders. Information being a public good, it would be ex post socially optimal to award a prize to the innovator and to disseminate the innovation at a low fee. Yet the patent system has proved to be an unexpectedly robust institution. That no one has come upwith a superior alternative is presumably due to the