Coalitions and recurrent negotiation in multilateral relational contracts

With Joel Watson

Abstract: We introduce a theory of coalitional governance of multilateral relational contracts. The coalition is a subset of the parties, called insiders. In an infinitely repeated game with voluntary transfers, the parties coordinate on an equilibrium that the coalition negotiates and renegotiates over time. The coalition's power derives exclusively from its ability to coordinate the behavior of both the insiders and outsiders, using promised rewards and punishments. We show that equilibrium contractual arrangements differ substantially between insiders and outsiders, due to the latter parties being unable to claim a share of surplus during the coalition's negotiations. Essentially, insiders create a long-term contract, with rewards and punishments extending beyond instances of renegotiation, whereas the relationship between insiders and outsiders can be characterized by a shorter-term contract in which rewards and punishments do not extend beyond instances of renegotiation. If renegotiation occurs each period, then the latter arrangements take the form of direct payments from insiders to outsiders.

To incorporate bargaining power in the theory and to explore applications, we develop the concept of coalition-directed contractual equilibrium. In the coalition directed equilibrium of a repeated public-goods game, the coalition maximizes surplus by outsourcing marginal contributions to outsiders—that is, if an insider is otherwise identical to an outsider, then in equilibrium the outsider makes greater contributions, while the insider obtains a higher payoff. We interpret our results in the context of two applications: global climate change negotiations, and partnership firms.

Working paper coming soon