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Relational Contracting, Negotiation, and External Enforcement

Author

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  • Watson, Joel
  • Miller, David A
  • Olsen, Trond E
Abstract
We study relational contracting and renegotiation in environments with external enforcement of long-term contractual arrangements. A long-term contract governs the stage games that the contracting parties will play in the future (depending on verifiable stage-game outcomes) until they renegotiate. In a contractual equilibrium, the parties choose their individual actions rationally, jointly optimize when selecting a contract, and exercise their relative bargaining power. Our main result is that in a wide variety of settings, the optimal contract is semi-stationary, with stationary terms for all future periods but special terms for the current period. In each period the parties renegotiate to this same contract. For example, in a simple principal-agent model with a choice of costly monitoring technology, the optimal contract specifies mild monitoring for the current period but intense monitoring for future periods. Because the parties renegotiate in each new period, intense monitoring arises only off the equilibrium path after a failed renegotiation. (JEL C73, C78, D23, D86)

Suggested Citation

  • Watson, Joel & Miller, David A & Olsen, Trond E, 2020. "Relational Contracting, Negotiation, and External Enforcement," University of California at San Diego, Economics Working Paper Series qt6ts1j6hf, Department of Economics, UC San Diego.
    • Handle: RePEc:cdl:ucsdec:qt6ts1j6hf
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    References listed on IDEAS

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    3. Ola Kvaløy & Trond E. Olsen, 2023. "Balanced Scorecards: A Relational Contract Approach," Journal of Accounting Research, Wiley Blackwell, vol. 61(2), pages 619-652, May.
    4. Chi, Chang Koo & Olsen, Trond E., 2018. "Relational Incentive Contracts and Performance Measurement," Discussion Paper Series in Economics 7/2018, Norwegian School of Economics, Department of Economics.
    5. Doruk Cetemen & Felix Zhiyu Feng & Can Urgun, 2019. "Contracting with Non-Exponential Discounting: Moral Hazard and Dynamic Inconsistency," Working Papers 2019-17, Princeton University. Economics Department..
    6. Fahn, Matthias & MacLeod, W. Bentley & Muehlheusser, Gerd, 2023. "Past and Future Developments in the Economics of Relational Contracts," IZA Discussion Papers 16427, Institute of Labor Economics (IZA).
    7. Joel Watson, 2021. "Theoretical Foundations of Relational Incentive Contracts," Annual Review of Economics, Annual Reviews, vol. 13(1), pages 631-659, August.

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    More about this item

    Keywords

    Relational contracts; negotiation; external enforcement; Economics; Commerce; Management; Tourism and Services;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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