Renegotiating Incomplete Contracts: Over and Under-Investment in Public Infraestructure

Abstract

This paper characterizes the equilibria of infrastructure franchising under incomplete contracting and ex–post renegotiation. The parties (government and a firm) are unable to credibly commit to the contracted investment plan, so that a second step investment (labeled as investments in service quality) is renegotiated by the parties in the revision stage. As expected, the possibility of renegotiation affects initial non-verifiable investments. The main conclusion of this paper is that not only under-investment but also over-investment in infrastructure may arise in equilibrium, compared to the complete contracting level.