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An Active-Contracting Perspective on Equilibrium Selection in Relational Contracts

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  • Miller, David A
  • Watson, Joel

Abstract

Miller andWatson (2013) introduced contractual equilibrium for repeated games with recurrent bargaining, axiomatizing how parties in a relational contract interpret the outcome of their negotiation. We show that modeling elements the previous literature used to study negotiation - elements that would seem to capture bargaining power and impose structure on equilibrium- actually do not affect the set of equilibrium payoffs, so that predictions depend on arbitrary equilibrium selection by the analyst. In contrast, contractual equilibrium puts equilibrium selection in the parties' hands, leading to sharp predictions. In a principal-agent setting, increasing the agent's bargaining power causes the equilibrium effort to rise, and play under disagreement depends on the history of effort choices.
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Suggested Citation

  • Miller, David A & Watson, Joel, 2023. "An Active-Contracting Perspective on Equilibrium Selection in Relational Contracts," University of California at San Diego, Economics Working Paper Series qt2dg817mv, Department of Economics, UC San Diego.
    • Handle: RePEc:cdl:ucsdec:qt2dg817mv
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    References listed on IDEAS

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    1. Matthias Fahn, 2017. "Minimum Wages and Relational Contracts," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 33(2), pages 301-331.
    2. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-1158, December.
    3. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June.
    4. Bergin James & MacLeod W. Bentley, 1993. "Efficiency and Renegotiation in Repeated Games," Journal of Economic Theory, Elsevier, vol. 61(1), pages 42-73, October.
    5. Garey Ramey & Joel Watson, 2002. "Contractual Intermediaries," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 18(2), pages 362-384, October.
    6. Ray Debraj, 1994. "Internally Renegotiation-Proof Equilibrium Sets: Limit Behavior with Low Discounting," Games and Economic Behavior, Elsevier, vol. 6(1), pages 162-177, January.
    7. Klimenko, Mikhail & Ramey, Garey & Watson, Joel, 2008. "Recurrent trade agreements and the value of external enforcement," Journal of International Economics, Elsevier, vol. 74(2), pages 475-499, March.
    8. Heidi Gjertsen & Theodore Groves & David A Miller & Eduard Niesten & Dale Squires & Joel Watson, 2021. "Conservation Agreements: Relational Contracts with Endogenous Monitoring," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 37(1), pages 1-40.
    9. Wouter J. Den Haan & Garey Ramey & Joel Watson, 1999. "Contract-theoretic approaches to wages and displacement," Review, Federal Reserve Bank of St. Louis, issue May, pages 55-68.
    10. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-460, March.
    11. Asheim, Geir B., 1991. "Extending renegotiation-proofness to infinite horizon games," Games and Economic Behavior, Elsevier, vol. 3(3), pages 278-294, August.
    12. David A. Miller & Joel Watson, 2013. "A Theory of Disagreement in Repeated Games With Bargaining," Econometrica, Econometric Society, vol. 81(6), pages 2303-2350, November.
    13. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Ekonomicheskaya Politika / Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 1-19.
    14. Joel Watson, 2013. "Contract and Game Theory: Basic Concepts for Settings with Finite Horizons," Games, MDPI, vol. 4(3), pages 1-40, August.
    15. Abrea Dilip & Pearce David & Stacchetti Ennio, 1993. "Renegotiation and Symmetry in Repeated Games," Journal of Economic Theory, Elsevier, vol. 60(2), pages 217-240, August.
    16. Kostadinov, Rumen, 2021. "Renegotiation of long-term contracts as part of an implicit agreement," Theoretical Economics, Econometric Society, vol. 16(4), November.
    17. Joel Watson, 2021. "Theoretical Foundations of Relational Incentive Contracts," Annual Review of Economics, Annual Reviews, vol. 13(1), pages 631-659, August.
    18. Douglas Bernheim, B. & Ray, Debraj, 1989. "Collective dynamic consistency in repeated games," Games and Economic Behavior, Elsevier, vol. 1(4), pages 295-326, December.
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    Cited by:

    1. Fahn, Matthias & MacLeod, W. Bentley & Muehlheusser, Gerd, 2023. "Past and Future Developments in the Economics of Relational Contracts," IZA Discussion Papers 16427, Institute of Labor Economics (IZA).

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    More about this item

    Keywords

    Economics; Applied Economics; Economic Theory; equilibrium selection; active contracting; bargaining power; relationships; Applied economics; Economic theory;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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