Contract and Game Theory: Basic Concepts for Settings with Finite Horizons

This paper examines a general model of contract in multi-period settings with both external and self-enforcement. In the model, players alternately engage in contract negotiation and take individual actions. A notion of contractual equilibrium, which combines a bargaining solution and individual incentive constraints, is proposed and analyzed. The modeling framework helps identify the relation between the manner in which players negotiate and the outcome of the long-term contractual relationship. In particular, the model shows the importance of accounting for the self-enforced component of contract in the negotiation process. Examples and guidance for applications are provided, along with existence results and a result on a monotone relation between “activeness of contracting” and contractual equilibrium values.