UPF, Barcelona GSE, and

This paper formalizes the idea that contracting partners can engage in post-contractual opportunistic behavior aimed at circumventing the original intention of their agree-ment. We show that anticipation and observability of such behavior are typically not enough to prevent its occurrence. This is true if message games are allowed and parties renegotiate any ine ¢ cient contractual outcome. Any contractually speci\u85ed incentives unavoidably have conicting e¤ects: they increase the likelihood of welfare improving investments and at the same time they increase the likelihood of (welfare reducing) op-portunistic behavior. Thus opportunism reduces the value of contracting by limiting the e¤ectiveness of contractual incentives. We provide conditions for the optimality of incomplete contracts, a simple characterization of the second-best contract, and some comparative statics. We demonstrate the usefulness of our framework by relating it to the property rights and transaction costs theories of the \u85rm. (JEL D23, J41, K12, L22