Contract (Re-)Negotiation with Private and Common Values

Abstract

Die Dis cus si on Pape rs die nen einer mög lichst schnel len Ver brei tung von neue ren For schungs arbei ten des ZEW. Die Bei trä ge lie gen in allei ni ger Ver ant wor tung der Auto ren und stel len nicht not wen di ger wei se die Mei nung des ZEW dar.Dis cus si on Papers are inten ded to make results of ZEW research prompt ly avai la ble to other eco no mists in order to encou ra ge dis cus si on and sug gesti ons for revi si ons. The aut hors are sole ly respon si ble for the con tents which do not neces sa ri ly repre sent the opi ni on of the ZEW. CONTRACT (RE-)NEGOTIATION WITH PRIVATE AND COMMON VALUES VITALI GRETSCHKO AND ACHIM WAMBACH ZEW MANNHEIM AND UNIVERSITY OF MANNHEIMAbstract. We analyze the contracting problem of a principal who faces an agent with private information and cannot commit to not renegotiating a chosen contract. We model this by allowing the principal to propose new contracts any number of times after observing the contract choice of the agent. We propose a characterization of renegotiation-proof states of this (re-)negotiation and show that those states are supported by a perfect Bayesian equilibrium of an infinite horizon game. The characterization of renegotiation-proof states provides a tool, which is both powerful and simple to use, for finding such states in specific environments. We proceed by applying the results to adverse selection environments with private and common values. We show that with private values and common values of the 'Spence' type only, fully efficient and separating states can be renegotiation-proof. With common values of the "Rothschild-Stiglitz" type inefficient and (partial) pooling states may be renegotiation-proof.JEL classification: C73, C78, D82

Contract Design with Limited Commitment

“…In this section we closely follow Gretschko and Wambach (2016) and identify renegotiationproof states. That is, states C t = (w t−1 , µ t−1 ), such that the principal will not renegotiate w t−1 .…”

“…That is, states C t = (w t−1 , µ t−1 ), such that the principal will not renegotiate w t−1 . We extend the definitions in Gretschko and Wambach (2016) by considering arbitrary type spaces and not merely discrete ones. In Section 6, we demonstrate that renegotiation-proof states arise from mechanism selection strategies that are consistent and optimal in the sense of Vartiainen (2013).…”

“…If the principal cannot commit to not renegotiating any contract and there is no deadline that puts an end to the renegotiation, backward induction cannot be applied and the revelation principle is hard to restore. 1 We follow Gretschko and Wambach (2016) and characterize the set of renegotiationproof states of such a (re-)negotiation. 2 A state of the negotiation is a tuple consisting of the current signed contract of the agent and the belief of the principal that was formed by observing the previous choices of the agent.…”

“…We extend the definitions in Gretschko and Wambach (2016) by considering arbitrary type spaces and not merely discrete ones.…”

“…Related literature. Gretschko and Wambach (2016) show how renegotiation-proof states arise as a perfect Bayesian equilibrium of the mechanism design game. Furthermore, they apply the solution concept to different models with a discrete type space.…”