Communication and Renegotiation
27 Pages Posted: 25 Aug 2004
Date Written: August 24, 2004
In a bilateral monopoly, we are looking at the seller's incentives to propose an improved widget design under two different negotiation rules. With Renegotiation, the players negotiate a price after a design has been agreed upon, and with Commitment, they negotiate the price beforehand. The comparison depends on two effects. (1) Bargaining power: Since communication reveals information about his preferences, a seller with little bargaining power may prefer to remain quiet in anticipation of ex post negotiation. (2) Incentive transfer: If the gains from adjustment are large, ex post negotiation gives the seller a chance to share the gains. On balance, Renegotiation is better when adjustments are rare but large, while Commitment is better when adjustments are frequent but small. The comparison might help explain why some contracts have more features left incomplete and throw some light on the nature of the employment relationship.
Keywords: Contract Theory, Communication, Renegotiation
JEL Classification: D2, L2
Suggested Citation: Suggested Citation