Working Paper: CEPR ID: DP5292
Authors: Patrick W. Schmitz
Abstract: Recent work in the field of mechanism design has led some researchers to propose institutional changes that would permit parties to enter into non-modifiable contracts, which is not possible under current contract law. This paper demonstrates that it may well be socially desirable not to enforce contractual terms that explicitly prevent renegotiation, even if rational and symmetrically informed parties have deliberately signed such a contract. The impossibility to prevent renegotiation can constrain the principal's abilities to introduce distortions in order to reduce the agent's rent, so that the first-best benchmark solution will more often be attained.
Keywords: contract modification; moral hazard; renegotiation
JEL Codes: K12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Enforcing non-renegotiation clauses (L14) | Low effort (e = 0, 0) (C29) |
| Not enforcing non-renegotiation clauses (L49) | Higher effort levels (e = 1, 1) (D29) |
| Not enforcing non-renegotiation clauses (L49) | Better outcomes for both parties (L14) |
| Enforcing non-renegotiation clauses (L14) | Adverse effects on contractual efficiency (D86) |