Strategic Effects of Incomplete and Renegotiation-Proof Contracts

36 Pages Posted: 18 Mar 2009

See all articles by Emanuele Gerratana

Emanuele Gerratana

Columbia University - School of International & Public Affairs (SIPA)

Levent Kockesen

Koc University - Department of Economics

Date Written: March 18, 2009

Abstract

It is well known that non-renegotiable contracts with third parties may have an effect on the outcome of a strategic interaction and thus serve as a commitment device. We address this issue when contracts are renegotiable. More precisely, we analyze the equilibrium outcomes of two-stage games with renegotiation-proof third-party contracts in relation to the equilibrium outcomes of the same game without contracts. We assume that one of the parties in the contractual relationship is unable to observe everything that happens in the game when played by the other party. This implies that contracts are incomplete and we show that such incompleteness restricts the set of equilibrium outcomes to a subset of Nash equilibrium outcomes of the game without contracts. Introducing renegotiation, in general, imposes further constraints and in some games implies that only subgame perfect equilibrium outcomes can be supported. However, there is a large class of games in which non-subgame perfect equilibrium outcomes can also be supported, and hence, third-party contracts still have strategic implications even when they are renegotiable.

Keywords: Third-Party Contracts, Strategic Delegation, Incomplete Contracts, Renegotiation

JEL Classification: C72, C78, D86, L13

Suggested Citation

Gerratana, Emanuele and Kockesen, Levent, Strategic Effects of Incomplete and Renegotiation-Proof Contracts (March 18, 2009). Available at SSRN: https://ssrn.com/abstract=1362358 or http://dx.doi.org/10.2139/ssrn.1362358

Emanuele Gerratana

Columbia University - School of International & Public Affairs (SIPA) ( email )

420 West 118th Street
New York, NY 10027
United States

Levent Kockesen (Contact Author)

Koc University - Department of Economics ( email )

Rumeli Feneri Yolu
Sariyer 80910, Istanbul
Turkey

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