Leveled commitment contracts and strategic breach

In (automated) negotiation systems for self-interested agents, contracts have traditionally been binding. They do not accommodate future events. Contingency contracts address this, but are often impractical. As an alternative, we propose leveled commitment contracts. The level of commitment is set by breach penalties. To be freed from the contract, an agent simply pays the penalty to the other party. A self-interested agent will be reluctant to breach because the other party might breach, in which case the former agent is freed from the contract, does not incur a penalty, and collects a penalty from the breacher. We show that, despite such strategic breach, leveled commitment increases the expected payoff to both contract parties and can enable deals that are impossible under full commitment. Asymmetric beliefs are also discussed. Different decommitting mechanisms are introduced and compared. Practical prescriptions for market designers are provided. A contract optimizer is provided on the web. (C) 2001 Academic Press.