A Necessary Condition for Optimality in Renegotiation Design.

Williamson (1979) claims that in a buyer-seller relationship with observable but unverifiable investments and state of nature, the hold up of future benefits leads to underinvestment. Aghion, Dewatripont and Rey (1994) resolve it provided that the initial contract can specify a default option and allocate the bargaining power to either of the party in renegotiation. The necessity to rely on large financial hostage or a "once-for-all" monetary penalty to implement the latter hypothesis is open to criticism but we show that the extreme allocation of the bargaining power is generically a necessary condition to implement the first best investments.