The Renegotiation-Proofness Principle and Costly Renegotiation

Abstract

We study contracting and costly in settings of complete but unverifiable information, using the mechanism-design approach. We show how activity is best modelled in the fundamentals of the mechanism-design framework, so that noncontractibility of amounts to a constraint on the problem. We formalize and clarify the Renegotiation-Proofness Principle (RPP), which states that any state-contingent payoff vector that is implementable in an environment with can also be implemented by a mechanism in which does not occur in equilibrium. We observe that the RPP is not generally valid. However, we prove a general monotonicity result that confirms the RPP's renegotiation is bad message. Our monotonicity theorem establishes that the set of implementable state-contingent payoffs increases with the costs of renegotiation.