Moral Hazard and Renegotiation: Multi-Period Robustness

Abstract

Is the second best outcome of static agency models renegotiation proof? In models with one period of renegotiation, Fudenberg and Tirole (1990) answer no when the principal makes the offer, while Ma (1994) and Matthews (1995) answer yes when the agent makes the offer. This paper analyzes the robustness of these two claims when there are more periods of renegotiation. With a known number of periods, if the principal makes at least one offer, even if the agent makes the offer in every other period, the equilibrium is identical to Fudenberg and Tirole equilibrium. With an uncertain number of periods, the agency problem is even more severe than in the Fudenberg and Tirole model.

Keywords: Moral Hazard, Agency, Renegotiation

JEL Classification: D23, D82