Revealing the Value of Relationships

This paper studies optimal relational contracts when the value of the relationship between contracting parties is not commonly known. I examine a simplified, two-period version of the principal-agent model of Halac (2012), in which the principal has persistent private information about her outside option. The results capture the main lessons, showing why inefficiencies necessarily arise and how they depend on the parties' bargaining powers. When parties care enough about the future, revealing the value of the relationship requires the informed principal to have bargaining power, and to sometimes renege on her promises.