Renegotiation and conflict resolution in relational contracting

Renegotiation and conflict resolution are studied in relational contracting under subjective evaluation. Renegotiation has three effects. First, it makes the incentive pay scheme low powered: the maximum variation of compensation across performance levels is compressed and the contract is less extreme compared to the case without renegotiation. This effect is stronger when the players are less patient. Second, renegotiation typically renders termination impossible; the contract relies on a “low-morale” mechanism to enforce mutual cooperation. Finally, renegotiation compels the players to resolve their conflicts by selecting a contract that maximizes the lowest possible surplus along the path of the contract.