Contract as reference points: A new approach to contracting and its implication for relationships among levels of government

This paper draws on recent developments in contract theory, initiated by Oliver Hart since 2008 and qualified as Contract as Reference Point Theory (CRPT). I explores how the CRPT can be used to better analyse the contractual relationships among levels of government (or between the government and a private operator). The theory focuses on the issues raised by the ex post adaptation, interpretation and renegotiation of these contracts and points out that a contract cannot control ex post the behaviours of the parties. Henceforth, it might be useless to attempt to design either a sophisticated contractual arrangement that would endeavour to foresee response to any contingency, or a highly flexible contract that would grant authority to one of the parties when future adjustments will be needed because these contracts could be subject to divergence of interpretations, yielding aggrievement (disappointment) and shading (underperformance). Indeed the theory establish a clear distinction between the spirit of a contract and its letter, and highlight that parties can deliver performance only along the letter, while the other party expect a cooperative spirit in ex-post adapation when needed. The theory therefore calls for contracts that are less subject to interpretation and manipulability than the usual recommendations drawn from past theories. Everything being equal, more rigid or shorter term contracts should be preferred. Moreover the conditions in which contracts are negotiated and renegotiated are crucial to guarantee the legitimacy of mutual comitments.