Reconciliating Relational Contracting and Hold-Up : A Model of Repeated Negotiations

Game theoretic analysis of relational contracts typically studies Pareto-optimal equilibria of infinitely repeated games. We illustrate with several examples how this equilibrium selection rules out very intuitive hold-up concerns. This becomes apparent only when moving away from the stationary environment of repeated games to more general discounted stochastic games. The key problem is that Pareto-optimal equilibria, even if satisfying renegotiation-proofness, do not properly reflect plausible concerns of how today's actions affect future bargaining positions within the relationship. We propose and characterize an alternative equilibrium selection based on the notion that continuation play is repeatedly newly negotiated in a relationship. We illustrate how the concept naturally combines the trade-offs from relational contracting and hold-up concerns