RENEGOTIATION DESIGN WITH UNVERIFIABLE INFORMATION

This paper considers a buyer-seller relationship with observable but u nverifiable investments and/or random utility parameters. In such situ ations, it is known that contract renegotiation may prevent the implem entation of first-best outcomes. In this paper, we show however that e fficient investments and optimal risk-sharing can typically be achieve d provided the initial contract is able to monitor the ex post renegot iation process. Specifically, we focus on the following two features o f renegotiation design. First, default options in case renegotiation b reaks down; second, the allocation of all bargaining power to either c ontracting party. Moreover, we show that these two features can be obt ained in standard Rubinstein bargaining games through contractual prov isions, such as specific-performance clauses and penalties for delay ( or, equivalently, financial ''hostages'' refundable without interest).