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Economic and Legal Aspects of Costly Recontracting

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  • Alan Schwartz
  • Joel Watson

Abstract

This paper explores how the opportunity to recontract affects investment and trade in contractual relationships when it is assumed that renegotiation is costly. In this world, recontracting retains much of the benefit that has been ascribed to it, including the realization of any surplus that is available ex post. Costly recontracting also mitigates the well-known drawback, that parties who expect to renegotiate sometimes cannot credibly commit to invest efficiently. This is because the attractiveness of renegotiation decreases in recontracting costs. We show that the optimal contracting environment often involves moderate recontracting costs, which balance the beneficial and detrimental effects of renegotiation. Our re

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Bibliographic Info

Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm143.

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Date of creation: 01 May 2000
Date of revision: 01 Jan 2001
Handle: RePEc:ysm:somwrk:ysm143

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  1. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. 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.
  4. 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.
  5. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, Econometric Society, vol. 52(2), pages 449-60, March.
  6. Benjamin E. Hermalin and Michael L. Katz., 1990. "Moral Hazard and Verifiability: The Effects of Renegotiation in Agency," Economics Working Papers, University of California at Berkeley 90-141, University of California at Berkeley.
  7. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, Econometric Society, vol. 67(4), pages 741-782, July.
  8. Mathias Dewatripont & Philippe Aghion & Patrick Rey, 1994. "Renegotiation design with unverifiable information," ULB Institutional Repository 2013/9591, ULB -- Universite Libre de Bruxelles.
  9. Huberman, Gur & Kahn, Charles M, 1988. "Limited Contract Enforcement and Strategic Renegotiation," American Economic Review, American Economic Association, vol. 78(3), pages 471-84, June.
  10. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
  11. Joel S. Demski & David E.M. Sappington, 1991. "Resolving Double Moral Hazard Problems with Buyout Agreements," RAND Journal of Economics, The RAND Corporation, vol. 22(2), pages 232-240, Summer.
  12. Jolls, Christine, 1997. "Contracts as Bilateral Commitments: A New Perspective on Contract Modification," The Journal of Legal Studies, University of Chicago Press, University of Chicago Press, vol. 26(1), pages 203-37, January.
  13. Chung, Tai-Yeong, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," Review of Economic Studies, Wiley Blackwell, vol. 58(5), pages 1031-42, October.
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Cited by:
  1. Gilboa, I. & Schmeidler, D., 1999. "Inductive Inference: an Axiomatic Approach," Papers 29-99, Tel Aviv.
  2. Ivo Welch, 2002. "Columbus' Egg: The Real Determinant of Capital Structure," NBER Working Papers 8782, National Bureau of Economic Research, Inc.
  3. Anderlini, Luca & Felli, Leonardo & Postlewaite, Andrew, 2001. "Courts of Law and Unforeseen Contingencies," CEPR Discussion Papers 2835, C.E.P.R. Discussion Papers.
  4. Watson, Joel & Brennan, Jim, 2002. "The Renegotiation-Proofness Principle and Costly Renegotiation," University of California at San Diego, Economics Working Paper Series qt4242n025, Department of Economics, UC San Diego.
  5. Arturo Bris & Ivo Welch, 2001. "The Optimal Concentration of Creditors," NBER Working Papers 8652, National Bureau of Economic Research, Inc.
  6. Grosskopf Ofer & Medina Barak, 2007. "Rationalizing Drennan: On Irrevocable Offers, Bid Shopping and Binding Range," Review of Law & Economics, De Gruyter, vol. 3(2), pages 321-361, August.

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