Time-Inconsistent Bargaining and Cross-Commitments

Abstract

The paper studies bargaining games involving players with present-biased preferences. The paper shows that the relative timing of bargaining rewards and bargaining costs will determine whether the players’ present-bias will affect bargaining outcomes. In cases where players agree to a bargain in period 1 and experience all bargaining payoffs in period 2, the players will act in a time-consistent fashion. When time-inconsistent players incur immediate bargaining costs to produce delayed rewards, they will have an incentive to procrastinate. On the other hand, when players receive immediate bargaining rewards and incur delayed costs, they will have incentives to agree to bargains too soon and to agree to inefficient bargains. The paper shows that the players’ awareness of their own and the other player’s present-biased preferences will determine whether they engage in repeated time-inconsistent bargaining. A naïve player who engages in time-inconsistent bargaining will suffer welfare losses. We show that time-inconsistent bargaining can also create spillover welfare losses for other players. A time-consistent player who is counterparty-naïve about the other player can suffer spillover welfare losses that can be higher than those incurred by the time-inconsistent player. As a result, counterparty-sophisticated players will have an incentive to use cross-commitment devices to reduce the likelihood of spillover welfare losses. The paper also shows that cross commitment devices that target immediate payoffs dominate cross-commitments that target delayed payoffs. Finally, the paper shows that time-inconsistent bargaining can lead to inefficient delays in agreeing to bargains and in exiting bargaining relationships.