Mechanism Design with Renegotiation and Costly Messages
The paper studies a general model of hold-up in a setting encompassing the models of Segal (1999) and Che and Hausch (1999) among others. It is shown that if renegotiation is modelled as an infinite-horizon non-cooperative bargaining game then, with a simple initial contract, an efficient equilibrium will generally exist. The contract gives authority to one party to set the terms of trade and gives the other party a non-expiring option to trade at these terms. The difference from standard results arises because the existing contract ensures that the renegotiation game has multiple equilibria; the multiplicity of continuation equilibria can be used to enforce efficient investment.