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Renegotiation of Sales Contracts

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  • Steven A. Matthews

Abstract

Contracts adopted with later renegotiation in mind may take simple forms. In a principal-agent model, if renegotiation may occur after the agent chooses efforet, the principal protects against unfavorable renegotiation by "selling the project" to the agent via a sales contract. If only singleton (single-scheme) contracts are feasible, the equilibrium initial contract must be a sales contract if the principal's renegotiation position will be inherently inferior in the sense that (a) the agent will have the bargianing power; (b) the principal will not observe the agent's effort, and (c) the agent has the talent, i.e. a rich set of feasible efforts, to exploint contractual nuances. Renegotiation necessarily occurs, and it yields (second-best) efficient allocations. Even when meny (multiple-scheme) contracts are available, if the selection of a scheme from a menu entails any cost, then the final contract is a singleton and equilibrium renegotiation occurs. If there is any complexity cost to specifying a menuy, the initional contract must also be a singleton; it is necessarily a sales contract if the agent has talent. A weak forward induction refinement criterion is used to obtain these results.

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Bibliographic Info

Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1051.

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Date of creation: Jun 1993
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Handle: RePEc:nwu:cmsems:1051

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Keywords: contracts; principal-agent; moral hazard; renegotiation; incentives;

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  1. Cho, In-Koo & Kreps, David M, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 179-221, May.
  2. Roger B. Myerson, 1981. "Mechanism Design by an Informed Principal," Discussion Papers 481, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
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  8. Hermalin, Benjamin E & Katz, Michael L, 1991. "Moral Hazard and Verifiability: The Effects of Renegotiation in Agency," Econometrica, Econometric Society, vol. 59(6), pages 1735-53, November.
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  19. repec:fth:inseep:9302 is not listed on IDEAS
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Citations

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Cited by:
  1. Steven Matthews, 2002. "Moral Hazard and Capital Structure Dynamics (joint with Mathias Dewatripont and Patrick Legros) Note the special time," Theory workshop papers 357966000000000095, UCLA Department of Economics.
  2. Dewatripont, Mathias & Legros, Patrick & Matthews, Steven A, 2002. "Moral Hazard and Capital Structure Dynamics," CEPR Discussion Papers 3487, C.E.P.R. Discussion Papers.
  3. Susanne Ohlendorf & Patrick W. Schmitz, 2012. "Repeated Moral Hazard And Contracts With Memory: The Case Of Risk‐Neutrality," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(2), pages 433-452, 05.
  4. De Fraja, Gianni, 1999. "After You Sir. Hold-Up, Direct Externalities, and Sequential Investment," Games and Economic Behavior, Elsevier, vol. 26(1), pages 22-39, January.
  5. Patrick W. Schmitz, 2005. "Should Contractual Clauses that Forbid Renegotiation Always be Enforced?," Bonn Econ Discussion Papers bgse26_2005, University of Bonn, Germany.
  6. Hiroshi Osano & Mami Kobayashi, 2003. "Double Moral Hazard and Renegotiation," KIER Working Papers 563, Kyoto University, Institute of Economic Research.
  7. Gul, Faruk, 2001. "Unobservable Investment and the Hold-Up Problem," Econometrica, Econometric Society, vol. 69(2), pages 343-76, March.
  8. Ching-mann Huang & Len-kuo Hu & Hsin-Hong Kang, 2005. "Compensation Design and Career Concerns of Fund Manager," Review of Quantitative Finance and Accounting, Springer, vol. 24(4), pages 379-397, June.
  9. Anderlini, Luca & Felli, Leonardo, 1998. "Describability and agency problems," European Economic Review, Elsevier, vol. 42(1), pages 35-59, January.
  10. Francesco Squintani, 1999. "Moral Hazard," Discussion Papers 1269, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Ohlendorf, Susanne & Schmitz, Patrick W., 2008. "Repeated Moral Hazard, Limited Liability, and Renegotiation," CEPR Discussion Papers 6725, C.E.P.R. Discussion Papers.

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