Multilateral Contracting with Externalities

This paper proposes a model for multilateral contracting, where contracts are written and renegotiated over time, and where contracts may impose externalities on other agents. Equilibria always exist and the equilibrium value function is linear and monotonically increasing on the contracts. If the grand coalition, or contracting among all agents, is inefficient we show that bargaining delays arise in positive-externality games and equilibrium inefficiency may remain bounded away from zero even as bargaining frictions converge to zero. Otherwise, if the grand coalition is efficient, there are no bargaining delays, convergence to the grand coalition occurs in a finite number of contracting rounds, and the outcome becomes efficient as players become more patient. jel: C71, C72, C78, D62 keywords: Contracts, externalities, renegotiation, coalitional bargaining ∗I thank Eddie Dekel (the editor) and two anonymous referees for many thoughtful comments. Thanks also to the seminar participants at the University of North Carolina, University of Pennsylvania, Princeton University, University of Rochester, the 1st World Congress of the Game Theory Society in Bilbao, the 8th World Congress of the Econometric Society in Seattle, the 2nd Meeting of the Society for Economic Design, and the 7th Meeting of the Society for Computational Economics, and to the Rodney L. White Center for Financial Research for financial assistance. Earlier drafts of this paper were entitled “Multilateral Negotiations and Formation of Coalitions”. Address: The Wharton School-Finance Dept., 2300 Steinberg Hall-Dietrich Hall, Philadelphia, PA 19104. E-mail: [email protected]. Tel: (215) 898-3477. Web page: http://finance.wharton.upenn.edu/~gomes.