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Incomplete contracting, renegotiation, and expectation-based loss aversion

Fabian Herweg (), Heiko Karle () and Daniel Müller

Journal of Economic Behavior & Organization, 2018, vol. 145, issue C, 176-201

Abstract: We consider a simple trading relationship between an expectation-based loss-averse buyer and a profit-maximizing seller. When writing a long-term contract the parties have to rely on renegotiation in order to ensure materially efficient trade ex post. We show that if the buyer expects renegotiation to occur, the seller can opportunistically exploit the buyer's attachment to the expected outcome of renegotiation. In other words, incomplete contracts create a new type of hold-up problem. If credible, the buyer prefers to expect not to renegotiate, which gives rise to ex post inefficiencies. In a next step, we allow the buyer to undertake a non-contractible investment. We find that loss aversion can mitigate the traditional hold-up problem.

Keywords: Behavioral contract theory; Expectation-based loss aversion; Hold-up problem; Incomplete contracts; Renegotiation (search for similar items in EconPapers)
JEL-codes: C78 D03 D86 (search for similar items in EconPapers)
Date: 2018
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Related works:
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014) Downloads
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014) Downloads
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014) Downloads
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:145:y:2018:i:c:p:176-201

DOI: 10.1016/j.jebo.2017.07.033

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