| Contingency and renegotiation are two critical components of financial contracting. I develop a theoretical framework in which the primary purpose of ex-ante contingencies is to shape the ex-post renegotiation game. The model analyzes how contingencies should be written when renegotiation is almost inevitable. Pricing grids establish the outside options in case renegotiation breaks down, as well as shift surplus. A competitive financing market ensures that the outside options are feasible. Debt maturity is used to allocate bargaining power. Sufficient conditions of the contracting environment are found for which renegotiation is optimal. The results from the model have empirical support and also yield new empirical predictions. |
