Economic and Legal Aspects of Costly Recontracting

37 Pages Posted: 9 May 2000

See all articles by Alan Schwartz

Alan Schwartz

Yale Law School

Joel Watson

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

Multiple version iconThere are 2 versions of this paper

Date Written: April 2000

Abstract

This paper explores how the opportunity to recontract affects investment and trade in contractual relationships when it is assumed that renegotiation is costly. In this world, recontracting retains much of the benefit that has been ascribed to it, including the realization of any surplus that is available ex post. Costly recontracting also mitigates the well-known drawback, that parties who expect to renegotiate sometimes cannot credibly commit to invest efficiently. This is because the attractiveness of renegotiation decreases in recontracting costs. We show that the optimal contracting environment often involves moderate recontracting costs, which balance the beneficial and detrimental effects of renegotiation. Our result stands in contrast to those derived in common models that assume unrealistically either that recontracting costs are zero or that they are infinite. We discuss implications for the design of legal institutions, governance systems, and contractual form.

JEL Classification: K12

Suggested Citation

Schwartz, Alan and Watson, Joel, Economic and Legal Aspects of Costly Recontracting (April 2000). Yale Law School, Law & Economics Working Paper No. 242. Available at SSRN: https://ssrn.com/abstract=224444 or http://dx.doi.org/10.2139/ssrn.224444

Alan Schwartz

Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4030 (Phone)
203-432-8260 (Fax)

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)

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