On renegotiation design

A central concern of contract theory is to investigate departures from the ‘first-best’ paradigm, in which rational agents could in principle achieve unrestrained efficiency through complete, long-term contingent contracts. In order to take into account some of the observed limitations in ‘real life’ contracts, attention has been paid to informational problems. One focus has been on asymmetries of information between contractors. Adverse selection and moral hazard have been used for example to analyze insurance problems, labor contracts, managerial incentives, regulation of monopolies, vertical restraints or the financial structure of firms [see for example HartHolmstrom (1987) for a survey of these issues]. Attention has also been devoted to private information shared by the parties but unavailable to outsiders like courts, that is, observable but unverifiable information. Asymmetries of information between contractors introduce constraints which indeed, most often, prevent to achieve first-best efficiency. Unfortunately, this paradigm involves technical difficulties (which explains why most contributions focus on ‘unidimensional’ asymmetries), and may leave some undeterminacies as to the form of optimal contracts (e.g. if there are more than ‘one’ asymmetry) or the ‘size’ of the inetliciencies (there may for instance exist several ‘equilibria’, which are more or less inefficient). The last paradigm (observable, but unverifiable, information) is technically more convenient. What is not clear, however, is the extent to which the presence of unverifiable information may prevent achieving first-best