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The Renegotiation-Proofness Principle and Costly Renegotiation

  • Author(s): Watson, Joel
  • Brennan, Jim
  • et al.
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.

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