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)
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 â€œonce-for-allâ€ 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 Reichelsteinâ€™s (1996) ï¬ rst best result with non-extreme allocation of the bargaining power is therefore a non-generic counter-example
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