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A necessary condition for optimality in renegotiation design

Nicolas Boccard ()

No 1998052, CORE Discussion Papers from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: Williamson (1979) claims that in a buyer-seller relationship with observable but unveriï¬ able investments and state of nature, the hold up of future beneï¬ ts leads to underinvestment. Aghion, Dewatripont and Rey (1994) resolve it provided that the initial contract can specify a default option and allocate the bargaining power to either of the party in renegotiation. The necessity to rely on large ï¬ nancial hostage or a “once-for-all†monetary penalty to implement the latter hypothesis is open to criticism but we show that the extreme allocation of the bargaining power is generically a necessary condition to implement the ï¬ rst best investments. Edlin and Reichelstein’s (1996) ï¬ rst best result with non-extreme allocation of the bargaining power is therefore a non-generic counter-example

Date: 1998-09-01
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