Abstract: Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation
since states of the world are often describable, foreseeable, and yet are not mentioned in a contract.
Asymmetric information theories also have limitations. We offer an explanation based on “contracts as
reference points”. Including a contingency of the form, “The buyer will require a good in event E”, has a
benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the
additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E.
We show that if parties agree about a reasonable division of surplus, an incomplete contract can be
strictly superior to a contingent contract.