CONTRACT RENEGOTIATION IN A CONTINUOUS STATE-SPACE

When players are unable to write complete state contingent contracts i t is shown, within the context of a non-cooperative contracting-renego tiation game, that the only subgame perfect equilibrium allocations ar e those that correspond to the set of first-best allocations. Players are able to implement this set of allocations by signing an initial co ntract that is subsequently renegotiated in all states of the world. T he contracting-renegotiation problem is complicated in an interesting way by assuming that the state space is continuous. The issue of the e xistence of an initial contract, that is subsequently renegotiated to the set of first-best allocations, must be resolved. Unlike Aghion, De watripont and Rey [1994], the results here do not require nor depend u pon the comonotonicity of the objective functions.