NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Contract Renegotiation in Agency Problems

Aaron S. Edlin, Benjamin E. Hermalin

NBER Working Paper No. 6086
Issued in July 1997
NBER Program(s):   LE

This paper studies the ability of an agent and a principal to achieve the first-best outcome when the agent invests in an asset that has greater value if owned by the principal than by the agent. When contracts can be renegotiated, a well-known danger is that the principal can hold up the agent, undermining the agent's investment incentives. We begin by identifying a countervailing effect: Investment by the agent can increase his value for the asset, thus improving his bargaining position in renegotiation. We show that option contracts will achieve the first best whenever this threat-point effect dominates the holdup effect. Otherwise, achieving the first best is difficult and, in many cases, impossible. In such cases, we show that if parties have an appropriate signal available, then the first best is still attainable for a wide class of bargaining procedures. A noisy signal, however, means that the optimal contract will involve terms that courts might view as punitive and so refuse to enforce.

download in pdf format
   (580 K)

email paper

This paper is available as PDF (580 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w6086

Published: Edlin, Aaron S. and Benjamin E. Hermalin. "Contract Renegotiation And Options In Agency Problems," Journal of Law, Economics and Organization, 2000, v16(2,Oct), 395-423.

Users who downloaded this paper also downloaded these:
Prendergast w8445 Consumers and Agency Problems
Morck and Yeung w16490 Agency Problems and the Fate of Capitalism
Adams, Hermalin, and Weisbach w14486 The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us