Renegotiation

I came across a working paper by Barron, Gibbons, Gil, and Murphy (BMMG henceforth) in which they look at the contracting between distributors and exhibitors of Spanish movie industry. The contracting seems to be half form and half relational in the sense that the distributors and exhibitors formally agree upon how to divide the revenue ex ante but renegotiation is a possibility (and usually is exercised) ex post (after the screening ends). The main part of the paper is empirical which I skipped. However they do include two simple models for illustration. The second one is a multi-unit auction model which I again skipped; the first one is more of my interest which is a relational contract model. Looking into it more closely, I realized how simplified the model it (it seems very similar to a toy model discussed in Kozsegi’s behavioral contract survey paper). In a nutshell, nothing is new there; renegotiation occurs after the resolution of uncertainty and is motivated by continuation value.

Then I grew some vague interests into renegotiation and started to think about the implications of loss aversion on that. There is a paper by Herweg (right who else; such a fan) and Schmidt published on RESud in 2014. They investigate the effects of loss aversion on renegotiation; the reference point is set to be the ex-ante contract. Unsurprisingly, loss aversion hinders renegotiation thus imposes additional welfare loss (besides the part created by the loss function of course). The paper also touches upon authority contract, which I did not exactly understand. Though it seems to me that the paper focuses on what I call ex-post flexibility, such as the likelihood of renegotiation. On the other hand, ex-ante flexibility is rarely if at all mentioned. Hart and Moore 2008 (oh how much I like this paper) suggest that loss aversion also reduces the value of ex-ante flexibility. They assume that parties feel entitled to the best possible outcome allowed by the contract and would revenge by shading if it is not achieved ex post. As a result, a more inclusive contract creates entitlements to better outcomes thus increases the chance of shading. One avenue that is potentially interesting is to look at whether these two forms of flexibility is substitute or complement and which form is optimal given different level of loss aversion.

References
[1]Barron, Daniel, et al. Relational Adaptation under Reel Authority. mimeo MIT, 2015.
[2]Herweg, Fabian, and Klaus M. Schmidt. “Loss aversion and inefficient renegotiation.” The Review of Economic Studies (2014): rdu034.
[3]Hart, Oliver, and John Moore. “Contracts as reference points.” The Quarterly Journal of Economics 123.1 (2008): 1-48.