The Renegotiation-Proofness Principle and Costly Renegotiation

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The Renegotiation-Proofness Principle and Costly Renegotiation

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Jim Brennan
Joel Watson

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Joel Watson

Abstract

We study contracting and costly renegotiation in settings of complete but unverifiable information, using the mechanism-design approach. We show how renegotiation activity is best modelled in the fundamentals of the mechanism-design framework, so that noncontractibility of renegotiation amounts to a constraint on the problem. We formalize and clarify the Renegotiation-Proofness Principle (RPP), which states that any state-contingent payoff vector that is implementable in an environment with renegotiation can also be implemented by a mechanism in which renegotiation does not occur in equilibrium. We observe that the RPP is not generally valid. However, we prove a general monotonicity result that confirms the RPP's "renegotiation is bad" message. Our monotonicity theorem establishes that the set of implementable state-contingent payoffs increases with the costs of renegotiation.

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Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number 2002-10.

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Date of creation: May 2002
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Handle: RePEc:cdl:ucsdec:2002-10

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Bull, Jesse & Watson, Joel, 2004. "Evidence disclosure and verifiability," Journal of Economic Theory, Elsevier, vol. 118(1), pages 1-31, September. [Downloadable!] (restricted)
Other versions:
- Jesse Bull & Joel Watson, 2000. "Evidence Disclosure and Verifiability," University of California at San Diego, Economics Working Paper Series 2000-16, Department of Economics, UC San Diego. [Downloadable!]
- Jesse Bull & Joel Watson, 2002. "Evidence Discloure and Verifiability," University of California at San Diego, Economics Working Paper Series 2000-16r, Department of Economics, UC San Diego. [Downloadable!]
Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," Harvard Institute of Economic Research Working Papers 1863, Harvard - Institute of Economic Research.
Other versions:
- Maskin, Eric & Moore, John, 1999. "Implementation and Renegotiation," Review of Economic Studies, Blackwell Publishing, vol. 66(1), pages 39-56, January. [Downloadable!] (restricted)
Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law & Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
Bernheim, B Douglas & Whinston, Michael D, 1998. "Incomplete Contracts and Strategic Ambiguity," American Economic Review, American Economic Association, vol. 88(4), pages 902-32, September. [Downloadable!] (restricted)
Other versions:
- B. Douglas Bernheim & Michael D. Whinston, 1997. "Incomplete Contracts and Strategic Ambiguity," Harvard Institute of Economic Research Working Papers 1787, Harvard - Institute of Economic Research.
Hart, Oliver D & Tirole, Jean, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Blackwell Publishing, vol. 55(4), pages 509-40, October. [Downloadable!] (restricted)
Other versions:
- Oliver D. Hart & Jean Tirole, 1987. "Contract Renegotiation and Coasian Dynamics," Working papers 442, Massachusetts Institute of Technology (MIT), Department of Economics.
Alan Schwartz & Joel Watson, 2001. "The Law and Economics of Costly Contracting," University of California at San Diego, Economics Working Paper Series 2001-21, Department of Economics, UC San Diego. [Downloadable!]
Other versions:
- Alan Schwartz & Joel Watson, . "The Law and Economics of Costly Contracting," Yale Law School John M. Olin Center for Studies in Law, Economics, and Public Policy Working Paper Series yale_lepp-1004, Yale Law School John M. Olin Center for Studies in Law, Economics, and Public Policy. [Downloadable!]
- Alan Schwartz, 2004. "The Law and Economics of Costly Contracting," Journal of Law, Economics and Organization, Oxford University Press, vol. 20(1), pages 2-31, April.
Alan Schwartz & Joel Watson, 2000. "Economic and Legal Aspects of Costly Recontracting," University of California at San Diego, Economics Working Paper Series 2000-05, Department of Economics, UC San Diego. [Downloadable!]
Other versions:
- Joel C. Watson & Alan Schwartz, 2000. "Economic and Legal Aspects of Costly Recontracting," Yale School of Management Working Papers ysm143, Yale School of Management. [Downloadable!]
Green, Jerry & Laffont, Jean-Jacques, 1977. "Characterization of Satisfactory Mechanisms for the Revelation of Preferences for Public Goods," Econometrica, Econometric Society, vol. 45(2), pages 427-38, March. [Downloadable!] (restricted)
Jackson, Matthew O., 1999. "A Crash Course in Implementation Theory," Working Papers 1076, California Institute of Technology, Division of the Humanities and Social Sciences. [Downloadable!]
Other versions:
- Matthew O. Jackson, 2001. "A crash course in implementation theory," Social Choice and Welfare, Springer, vol. 18(4), pages 655-708. [Downloadable!] (restricted)
Yeon-Koo Che & Donald B. Hausch, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March. [Downloadable!] (restricted)
Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August. [Downloadable!] (restricted)
Other versions:
- Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
- Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January. [Downloadable!] (restricted)
Other versions:
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Dewatripont, Mathias, 1988. "Commitment through Renegotiation-Proof Contracts with Third Parties," Review of Economic Studies, Blackwell Publishing, vol. 55(3), pages 377-89, July. [Downloadable!] (restricted)
Maskin, Eric, 1999. "Nash Equilibrium and Welfare Optimality," Review of Economic Studies, Blackwell Publishing, vol. 66(1), pages 23-38, January. [Downloadable!] (restricted)
Other versions:
- Eric Maskin, 1998. "Nash Equilibrium and Welfare Optimality," Harvard Institute of Economic Research Working Papers 1829, Harvard - Institute of Economic Research.
Ilya Segal & Michael D. Whinston, 2002. "The Mirrlees Approach to Mechanism Design with Renegotiation (with Applications to Hold-up and Risk Sharing)," Econometrica, Econometric Society, vol. 70(1), pages 1-45, January. [Downloadable!] (restricted)
Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer. [Downloadable!] (restricted)
Other versions:
- Georg Nöldeke & Klaus M. Schmidt, 1992. "Option Contracts and Renegotiation - A Solution to the Hold-Up Problem," Discussion Paper Serie A 417, University of Bonn, Germany, revised Aug 1993.
Joel Watson, 2002. "Contract, Mechanism Design, and Technological Detail," Theory workshop papers 505798000000000006, UCLA Department of Economics. [Downloadable!]
Other versions:
- Joel Watson, 2002. "Contract, Mechanism Design, and Technological Detail," University of California at San Diego, Economics Working Paper Series 2002-04, Department of Economics, UC San Diego. [Downloadable!]
Thomson, William, 1987. "Monotonicity of bargaining solutions with respect to the disagreement point," Journal of Economic Theory, Elsevier, vol. 42(1), pages 50-58, June. [Downloadable!] (restricted)
Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-85, July. [Downloadable!] (restricted)
Other versions:
- Hardman Moore, John & Hart, Oliver, 1985. "Incomplete Contracts and Renegotiation," CEPR Discussion Papers 60, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
- Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
Jackson, Matthew O. & Palfrey, Thomas R., 2001. "Voluntary Implementation," Journal of Economic Theory, Elsevier, vol. 98(1), pages 1-25, May. [Downloadable!] (restricted)
Other versions:
- Jackson, Matthew O. & Palfrey, Thomas R., 1999. "Voluntary Implementation," Working Papers 1077, California Institute of Technology, Division of the Humanities and Social Sciences. [Downloadable!]
Rubinstein, Ariel & Wolinsky, Asher, 1992. "Renegotiation-Proof Implementation and Time Preferences," American Economic Review, American Economic Association, vol. 82(3), pages 600-614, June. [Downloadable!] (restricted)
Other versions:
- Ariel Rubinstein & Asher Wolinsky, 1990. "Renegotiation-Proof Implementation and Time Preferences," STICERD - Theoretical Economics Paper Series 215, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
- Ariel Rubinstein & Asher Wolinsky, 1989. "Renegotiation-Proof Implementation and Time Preferences," Discussion Papers 850, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]

Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Joel Watson, 2006. "Contract and Mechanism Design in Settings with Multi-Period Trade," University of California at San Diego, Economics Working Paper Series 2006-02, Department of Economics, UC San Diego. [Downloadable!]
Jesse Bull & Joel Watson, 2002. "Hard Evidence and Mechanism Design," University of California at San Diego, Economics Working Paper Series 2002-16, Department of Economics, UC San Diego. [Downloadable!]
Other versions:
- Joel Watson & Jesse Bull, 2006. "Hard Evidence and Mechanism Design," University of California at San Diego, Economics Working Paper Series 2002-16R, Department of Economics, UC San Diego. [Downloadable!]
- Joel Watson & Jesse Bull, 2004. "Hard Evidence and Mechanism Design," Econometric Society 2004 North American Winter Meetings 433, Econometric Society. [Downloadable!]
- Bull, Jesse & Watson, Joel, 2007. "Hard evidence and mechanism design," Games and Economic Behavior, Elsevier, vol. 58(1), pages 75-93, January. [Downloadable!] (restricted)
Joel Watson, 2006. "Contract and Game Theory: Basic Concepts for Settings with Finite Horizons," University of California at San Diego, Economics Working Paper Series 2006-01, Department of Economics, UC San Diego. [Downloadable!]
Jesse Bull & Joel Watson, 2002. "Evidence Discloure and Verifiability," University of California at San Diego, Economics Working Paper Series 2000-16r, Department of Economics, UC San Diego. [Downloadable!]
Other versions:
- Jesse Bull & Joel Watson, 2000. "Evidence Disclosure and Verifiability," University of California at San Diego, Economics Working Paper Series 2000-16, Department of Economics, UC San Diego. [Downloadable!]
- Bull, Jesse & Watson, Joel, 2004. "Evidence disclosure and verifiability," Journal of Economic Theory, Elsevier, vol. 118(1), pages 1-31, September. [Downloadable!] (restricted)

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