A necessary condition for optimality in renegotiation design

Nicolas M.M. 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 unverifiable investments and state of nature, the hold up of future benefits 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 financial 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 first best investments. Edlin and Reichelstein’s (1996) first 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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