Renegotiation and Information Revelation over Time: The Case of Optimal Labor Contracts

Abstract

The paper analyzes the issue of commitment in Grossman and Hart's model of optimal labor contracts under asymmetric information about firm profitability. We extend their framework by allowing employment to vary over time, at equidistant intervals. When both parties can precommit ex ante not to renegotiate the contract, this replicates the Grossman-Hart outcome each subperiod. When precommitment is not possible, information revealed through the contract can create Pareto-improving renegotiation opportunities, and the issue of optimal information revelation arises. The paper analyzes the impact of ex post Pareto-improving renegotiations on the optimal contract.

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