Journal Of The Econometric Society

An International Society for the Advancement of Economic
Theory in its Relation to Statistics and Mathematics

Edited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262

Econometrica: Nov, 1991, Volume 59, Issue 6

Moral Hazard and Verifiability: The Effects of Renegotiation in Agency<1735:MHAVTE>2.0.CO;2-N
p. 1735-1753

Benjamin E. Hermalin, Michael L. Katz

We examine the effects of renegotiation in an agency relationship. We show how renegotiation affects: (i) the set of actions the principal can induce the agent to take; and (ii) the cost of implementing a given action. We show that, when the principal receives an unverifiable signal of the agent's action, renegotiation can improve welfare. This result stands in contrast to Fudenberg and Tirole's (1990) finding that renegotiation lowers welfare when the principal receives no signal about the agent's action prior to renegotiation.

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