Option Contracts and Renegotiation - A Solution to the Hold-Up Problem

The paper analyzes the canonical hold-up model of Hart and Moore (1988) under the assumption that the courts can verify delivery of the good by the seller. We show that the first best can be achieved using simple "option contracts" which give the seller the right to decide whether or not trade takes place. Our result does not rely on "renegotiation design" but takes the renegotiation game as exogenously given. Furthermore, we characterize an interesting class of cases in which renegotiation is unnecessary to achieve the first best.