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The Renegotiation-Proofness Principle and Costly Renegotiation

  • Watson, Joel
  • Brennan, Jim

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 qt4242n025.

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Date of creation: 01 May 2002
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Handle: RePEc:cdl:ucsdec:qt4242n025
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  1. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  2. 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.
  3. Rubinstein, Ariel & Wolinsky, Asher, 1992. "Renegotiation-Proof Implementation and Time Preferences," American Economic Review, American Economic Association, vol. 82(3), pages 600-614, June.
  4. Bull, Jesse & Watson, Joel, 2004. "Evidence disclosure and verifiability," Journal of Economic Theory, Elsevier, vol. 118(1), pages 1-31, September.
  5. Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 39-56.
  6. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  7. Nöldeke, Georg & Schmidt, Klaus M., 1995. "Option contracts and renegotiation: A solution to the Hold-Up Problem," Munich Reprints in Economics 19329, University of Munich, Department of Economics.
  8. Schwartz, Alan & Watson, Joel, 2000. "Economic and Legal Aspects of Costly Recontracting," University of California at San Diego, Economics Working Paper Series qt4jr3g3h7, Department of Economics, UC San Diego.
  9. 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.
  10. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
  11. Watson, Joel & Buzard, Kristy, 2009. "Contract, Renegotiation, and Hold Up: General Results on the Technology of Trade and Investment," University of California at San Diego, Economics Working Paper Series qt3923q7kz, Department of Economics, UC San Diego.
  12. 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.
  13. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  14. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, vol. 62(2), pages 257-82, March.
  15. Pierpaolo Battigalli & Giovanni Maggi, 2002. "Rigidity, Discretion, and the Costs of Writing Contracts," American Economic Review, American Economic Association, vol. 92(4), pages 798-817, September.
  16. Jackson, Matthew O., 1999. "A Crash Course in Implementation Theory," Working Papers 1076, California Institute of Technology, Division of the Humanities and Social Sciences.
  17. Oliver D. Hart & Jean Tirole, 1987. "Contract Renegotiation and Coasian Dynamics," Working papers 442, Massachusetts Institute of Technology (MIT), Department of Economics.
  18. Buzard, Kristy & Watson, Joel, 2010. "Contract, Renegotiation, and Hold Up: Results on the Technology of Trade and Investment," University of California at San Diego, Economics Working Paper Series qt3df3q4vg, Department of Economics, UC San Diego.
  19. Eric Maskin, 1999. "Nash Equilibrium and Welfare Optimality," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 23-38.
  20. 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.
  21. Roger B. Myerson, 1977. "Incentive Compatability and the Bargaining Problem," Discussion Papers 284, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  22. Williamson, Oliver E, 1979. "Transaction-Cost Economics: The Governance of Contractural Relations," Journal of Law and Economics, University of Chicago Press, vol. 22(2), pages 233-61, October.
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