Renegotiation of Dynamically Incomplete Contracts
I provide a micro-foundation for dynamically incomplete contracts that are renegotiated over time. The micro-foundation is based on showing that such contracts implement the optimal complete contract in a general dynamic financial contracting model provided the players have “preference-for-robustness”. Preference-for-robustness is a class of dynamic max-min preferences defined in a setting where players have a fuzzy idea about events in the future. The paper culminates in an analysis of contracting under asymmetric information: The optimal dynamic contract under preference-for-robustness is shown to be a debt contract featuring state-contingent allocation of control rights and a refinance option.