An increase in the marginal cost arising from a more complex specialized investment environment will cause the optimal contract length to:
A) increase.
B) decrease.
C) remain constant.
D) either increase or decrease.

Question

Quizplus · Accepted Answer

An increase in marginal cost implies that it becomes more costly for the parties to monitor and enforce the contract, which makes shorter contracts more favorable. Therefore, the optimal contract length would decrease.

An Increase in the Marginal Cost Arising from a More