Implementing the First Best in an Agency Relationship with Renegotiation: A Corrigendum
The proof in Proposition 4 in Hermalin and Katz (1991) is incorrect because it fails to check post-renegotiation utilities against the incentive compatibility constraints. This note states and proves a comparable proposition with a slightly stronger assumption regarding the monotonicity of bargaining. This result vindicates the central intuition of Hermalin and Katz about the potential insignificance of the observable, but unverifiable distinction in contracting.
Aaron S. Edlin and Benjamin Hermalin. "Implementing the First Best in an Agency Relationship with Renegotiation: A Corrigendum" Econometrica 69 (2001).
Available at: http://works.bepress.com/hermalin/4