Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion

Fabian Herweg (), Heiko Karle and Daniel Müller

No 4687, CESifo Working Paper Series from CESifo

Abstract: We consider a simple trading relationship between an expectation-based loss-averse buyer and profit-maximizing sellers. When writing a long-term contract the parties have to rely on renegotiations in order to ensure materially efficient trade ex post. The type of the concluded long-term contract affects the buyer’s expectations regarding the outcome of renegotiation. If the buyer expects renegotiation always to take place, the parties are always able to implement the materially efficient good ex post. It can be optimal for the buyer, however, to expect that renegotiation does not take place. In this case, a good of too high quality or too low quality is traded ex post. Based on the buyer’s expectation management, our theory provides a rationale for “employment contracts” in the absence of non-contractible investments. Moreover, in an extension with non-contractible investments, we show that loss aversion can reduce the hold-up problem.

Keywords: behavioral contract theory; expectation-based loss aversion; incomplete contracts; renegotiation (search for similar items in EconPapers)
JEL-codes: C78 D03 D86 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Incomplete contracting, renegotiation, and expectation-based loss aversion (2018)
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014)
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014)
Working Paper: Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion (2014)
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