Overconfidence and Endogenous Contract Incompleteness

We set up a model on the hold-up problem with uncertain bargaining power and find that, when two agents are overconfident about their bargaining power ex ante, , both of them may endogenously choose incomplete contract over complete contract even when complete contracting is feasible. The intuition behind the result is that ceteris paribus, , overconfidence leads to a higher expected return to relation- specific investment and a higher investment level. Our model provides an additional behavioral explanation for the prevalence of contract incompleteness in addition to those existing in the literature.