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The Renegotiation-Proofness Principle and Costly Renegotiation

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  • Watson, Joel
  • Brennan, Jim

Abstract

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.

Suggested Citation

  • 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.
    • Handle: RePEc:cdl:ucsdec:qt4242n025
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    Cited by:

    1. Evelyn Korn & Stephan Meisenzahl, 2009. "Contracting still matters! Or: How to design a letter of intent," MAGKS Papers on Economics 200909, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    2. Joel Watson, 2013. "Contract and Game Theory: Basic Concepts for Settings with Finite Horizons," Games, MDPI, vol. 4(3), pages 1-40, August.
    3. Florin c{S}abac, 2007. "Dynamic Agency with Renegotiation and Managerial Tenure," Management Science, INFORMS, vol. 53(5), pages 849-864, May.
    4. Watson, Joel, 2006. "Contract and Mechanism Design in Settings with Multi-Period Trade," University of California at San Diego, Economics Working Paper Series qt63s1s3j6, Department of Economics, UC San Diego.
    5. Bull, Jesse & Watson, Joel, 2004. "Evidence disclosure and verifiability," Journal of Economic Theory, Elsevier, vol. 118(1), pages 1-31, September.
    6. Mostafa Beshkar, 2016. "Arbitration and Renegotiation in Trade Agreements," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 32(3), pages 586-619.
    7. Davies, Clem & Franke, Marcel & Kuang, Lida & Neumärker, Karl Justus Bernhard, 2022. "A contractarian view on homann's ethical approach: The vision of "new ordoliberalism"," The Constitutional Economics Network Working Papers 01-2022, University of Freiburg, Department of Economic Policy and Constitutional Economic Theory.
    8. Mostafa Beshkar, 2014. "Arbitration and Renegotiation in Trade Agreements," Caepr Working Papers 2014-004, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.

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    renegotiation; contracts;

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