The Renegotiation-Proofness Principle and Costly Renegotiation

UCSD Economics Discussion Paper No. 2002-10

28 Pages Posted: 23 Jul 2002

See all articles by Joel Watson

Joel Watson

University of California, San Diego (UCSD) - Department of Economics

Jim Brennan

University of California, San Diego (UCSD) - Department of Economics

Date Written: May 2002

Abstract

We study contracting and costly renegotiation in settings of complete but unverifiable information, using the mechanism-design approach. We show how renegotiation activity is best modelled in the fundamentals of the mechanism-design framework, so that noncontractibility of renegotiation amounts to a constraint on the problem. We formalize and clarify the Renegotiation-Proofness Principle (RPP), which states that any state-contingent payoff vector that is implementable in an environment with renegotiation can also be implemented by a mechanism in which renegotiation does not occur in equilibrium. We observe that the RPP is not generally valid. However, we prove a general monotonicity result that confirms the RPP's "renegotiation is bad" message. Our monotonicity theorem establishes that the set of implementable state-contingent payoffs increases with the costs of renegotiation.

Keywords: Contracting, Implementation, Mechanism Design, Renegotiation

JEL Classification: C70, D23, D70, K12

Suggested Citation

Watson, Joel and Brennan, Jim, The Renegotiation-Proofness Principle and Costly Renegotiation (May 2002). UCSD Economics Discussion Paper No. 2002-10, Available at SSRN: https://ssrn.com/abstract=318726 or http://dx.doi.org/10.2139/ssrn.318726

Joel Watson (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
La Jolla, CA 92093-0508
United States
858-534-6132 (Phone)
619-534-7040 (Fax)

Jim Brennan

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
La Jolla, CA 92093-0508
United States

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