Robustness in Contracts: Inferring Strategies from Past Play

Tridib Sharma ()

No 9803, Working Papers from Centro de Investigacion Economica, ITAM

Abstract: It is generally understood that in situations of asymmetric information, the principal is better off committing to long term contracts than committing to short term contracts. The result holds true even when long term contracts are constrained to be renegotiation proof. The paper argues that the longrun renegotiation proof contracts, which the literature uses as benchmarks for comparison, are not robust to the possibility of certain kinds of renegotiation. The renegotiations that we have in mind are those which (potentially)take place after the principal comprehends previous strategies of the agent by using behavioral or statistical techniques. We show that for 'high' discount factors the principal is not strictly better off by committing to longrun contracts that are robust to renegotiations.

Date: 1998-02

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