Econometrica: May, 1995, Volume 63, Issue 3

Renegotiation of Sales Contracts

https://doi.org/0012-9682(199505)63:3<567:ROSC>2.0.CO;2-C
p. 567-589

Steven A. Matthews

This paper studies moral hazard contracts that may be renegotiated after an agent chooses an unobservable effort. Unlike in previous models, a contract here contains only one compensation scheme, and the agent has all the bargaining power in the renegotiation stage. Using a relatively weak forward-induction refinement, all equilibria are shown to be (second-best) efficient. Renegotiation occurs in every equilibrium. If the effort set is rich, the only equilibrium initial contract is a sales contract, i.e., a scheme which "sells the project" to the agent. This captures the idea that a party (the principal) who has an inherently weak renegotiation position will sometimes insist on a simple initial contract.