Renegotiation and the Dynamics of Contract Design
نویسنده
چکیده
Besides sunk costs and reputation, long-term contracts are an important form of commitment. In fact, in the imaginary world of Arrow-Debreu there is no room for other forms of commitment than the fully contingent longterm contract. At the risk of oversimplification, one could describe a large part of the theoretical research effort of the past three decades as a systematic attempt at understanding the implications of gradually limiting the set of feasible long-term contracts further and further away from the set of fully contingent Arrow-Debreu contracts. Thus, the theory of incentives was born in the 1960s when information constraints were introduced. Later, other constraints relating to the difftculties of describing and verifying contractual performance have been imposed thus leading towards the first formal foundations of a theory of property rights and ownership. More recently, the role of renegotiation in limiting the commitment power of contracts has become the focus of attention. Basically, the possibility of renegotiation amounts to the addition of another constraint on the set of feasible contracts: now contracts must be not only ‘incentive compatible’ but also ‘renegotiation-proof. (When parties can commit not to renegotiate they have a choice of when to allow for renegotiation and when not. If this commitment possibility is withdrawn they are forced to renegotiate whenever there are ex-post gains from renegotiation. Since the outcome of this renegotiation is perfectly predictable they might as well write renegotiationproof contracts). The fact that renegotiation may drastically reduce the commitment possibilities of the contracting parties has already been recognized by
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