Renegotiation-Proof Contracts with Persistent Private Information∗

This paper introduces a new approach to model renegotiation in stochastic games and applies it to study how renegotiation shapes long-term contracts in principal-agent relationships with persistent private information. The structure of players’ payoff and state dynamics generates an algebraic structure over contractual equilibria and determines the set of alternatives considered through renegotiation. Using recent advances in functional stochastic differential equations, the paper derives an Observability Theorem and a Revelation Principle to address asymmetric information over persistent variables. Truthful renegotiation-proof contracts are characterized by a single number—their sensitivity to the agent’s report—and are self-correcting off the equilibrium path. The sensitivity of the optimal contract is increasing in information persistence and decreasing in players’ patience.