Relational Contracting, Repeated Negotiations, and Hold-Up∗

We propose a unified framework to study relational contracting and hold-up problems in infinite horizon stochastic games. We illustrate that with respect to long run decisions, the common formulation of relational contracts as Pareto-optimal public perfect equilibria is in stark contrast to fundamental assumptions of hold-up models. We develop a model in which relational contracts are repeatedly newly negotiated during relationships. Negotiations take place with positive probability each period and new negotiations cause bygones to be bygones. Traditional relational contracting and hold-up formulations are nested as opposite corner cases. Allowing for intermediate cases yields very intuitive results and sheds light on many plausible trade-offs that do not arise in these corner cases. We establish a general existence result and a tractable characterization for stochastic games in which money can be transferred. ∗An earlier version of this paper had the titel “Relational Contracting in Dynamic Stochastic Games: Repeated Negotiations and Hold-Up” †Department of Mathematics and Economics, Ulm University, [email protected]. I would like to thank the German Research Foundation (DFG) for an individual research grant for visiting Yale University. This project started while I was visiting the Cowles Foundation in Yale and continued while I was working at the Institute for Energy Economics at the University of Cologne. I immensely benefited from the great hospitality and stimulating environment at both places. ‡Department of Economics, University of Konstanz, [email protected]. We would like to thank Mehmet Ekmekci, Eduardo Faingold, Paul Heidhues, Johannes Hörner, David Miller, Larry Samuelson, Klaus Schmidt, Patrick Schmitz, Philipp Strack, Juuso Välimäki, Joel Watson and seminar participants at Arizona State University, UC San Diego, Yale, Bonn, Berlin and Munich for very helpful discussions.