| Abstract: | A decision-maker's limited attention is allocated between writingnew contracts and directing current contracts. More time spentwriting a new contract makes the contract more complete. A morecomplete 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 directedperiodically, is optimally less complete than a market contract,which is not directed. The completeness of relational contractsdecreases with the ability to direct contracts, since changingcircumstances can be dealt with later. In addition, the completenessof relational contracts increases with the ability to writenew contracts, since more complete relational contracts aredirected less frequently and leave more time for writing newcontracts. The optimal allocation of attention to relationalcontracts is socially efficient even though it does not maximizethe discounted expected returns of the firm. |
