Contract Renegotiation: A Simple Framework and Implications for Organization Theory.

This paper provides a unifying framework for studying renegotiation of contracts in the presence of asymmetric information. We show that interim renegotiation does not constrain the set of contracts attainable with full commitment, regardless of whether renegotiation offers are made by the informed or the uninformed agent. Ex post renegotiation, however, does constrain the set of attainable contracts. These constraints depend on the identity of the agent making the renegotiation offer. We then show how the theory of contract renegotiation can provide insights for organization theory. Specifically, we show how decentralization of decision making can be an optimal response to the threat of ex post renegotiation. Finally, we show that our framework can be used to analyse the trade-off between internal and external markets.