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Renegotiation of long-term contracts as part of an implicit agreement

Author

Listed:
  • Kostadinov, Rumen

    (Department of Economics, McMaster University)

Abstract

I study a repeated principal-agent game with long-term output contracts that can be renegotiated at will. Actions are observable but not contractible, so they can only be incentivised through implicit agreements formed in equilibrium. I show that contract renegotiation is a powerful tool for incentive provision, despite the stationarity of the environment. Continuation contracts are designed to punish deviations in noncontractible behaviour. If the equilibrium actions are observed, these contracts are renegotiated away. This form of anticipated renegotiation results in welfare improvements over outcomes attainable by one-period contracts, or by long-term contracts which are not renegotiated. When the principal is not protected by limited liability, first-best outcomes are attainable regardless of the impatience of the players. Equilibrium strategies are shown to satisfy various concepts of renegotiation-proofness.

Suggested Citation

  • Kostadinov, Rumen, 2021. "Renegotiation of long-term contracts as part of an implicit agreement," Theoretical Economics, Econometric Society, vol. 16(4), November.
    • Handle: RePEc:the:publsh:3357
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    Citations

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    Cited by:

    1. David A. Miller & Joel Watson, 2023. "An Active-Contracting Perspective on Equilibrium Selection in Relational Contracts," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 179(3-4), pages 530-561.
    2. 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).

    More about this item

    Keywords

    Long-term contracts; renegotiation; relational contracts;
    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
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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