Alternative Method to Resolve the Principal–Principal Conflict—A New Perspective Based on Contract Theory and Negotiation

Abstract

Liquidated damages mechanisms have been analyzed from a legal perspective and applied to real-world contracts. Due to the lack of application of LDs to common agency theory, this research explores whether the liquidated damages mechanism can resolve principal–principal conflicts under common agency. We combine the moral hazard model of common agency with non-cooperative dynamic game theory to analyze the influence of the liquidated damages mechanism on the agent and principals under the condition of complete information and incomplete information. We find that liquidated damages are the key factors affecting the optimal contract between the principal and agent. Since the agent does not terminate the current contract, a principal–principal conflict arises when another principal wishes to enter into a new contract with the common agent. We find that the agent terminates the existing contract and signs a new one with another principal. The injured party requires liquidated damages from the breaching party. Therefore, they will negotiate the number of liquidated damages. Liquidated damages cause the bargaining game to generate a unique subgame perfect Nash equilibrium and sequential equilibrium. We prove that only when liquidated damages belong to a specific interval does a mechanism generating the Pareto optimal solutions to solve the principal–principal conflicts under common agency exist. A common way to resolve this conflict is ensuring that the minority is subordinate to the majority. For the first time, we study how the liquidated damages mechanism solves multi-principal conflict. This is another perspective that can be used to solve the conflict. Therefore, our paper expands the method of resolving the conflict and extends the theory of common agency; we first show the delegation process. Our research can be applied to various situations and provide a rational decision-making basis for participants.

Keywords

• liquidated damages
• bargaining game
• common agency
• principal–principal conflicts