Peter Buisseret and Dan Bernhardt date one,that is,if r =1,then the status quo transfer s2 Finally,if the date-two surplus from agreement is is the transfer b that DG accepted.If the project was negative;that is,if Equation(1)does not hold,then no not implemented,that is,if r =0,then the status quo amendment will be agreed upon,as the joint surplus transfer that serves as the starting point for date-two from implementing the project is negative.The project negotiations is s2 =s1. will not be implemented and all agents receive date- Because there are no bargaining frictions,the project one payoffs of zero. will be implemented at the terminal date t =2 if and The expected date-two payoff of a domestic agent only if the associated surplus is positive;that is,if and with date-one project valuation v who anticipates that only if the DG2 will have project valuation vp and face status quo transfer s2 is thus v2+1+vF≥0←→入≥-(2+UF) (1) VD(v,vp,s2)= (v+s2+)f()d Even though the date-two implementation decision -(+) does not depend on date-one actions,the division of (听+s2 the surplus depends on (a)the status quo transfer and (v-v哈+(u哈+入+vF)f()d. (b)the shock realization A. Suppose,first,that DG2 has a high enough project (3) valuation p+A that it would receive a positive pay- off from implementing the project when it receives the The expected date-two project payoff of FG given s2 status-quo transfer s2: when it faces DG2 with valuation v is 令 2+1+52≥0←→入≥-(u哈+s2) (2) Vr(2,s2) (vF-s2)f()d -(听+s2) With probability 6,DG2 is recognized to propose a modification to the inherited terms,s2.Because DG2 (1-)(2+入+vF)f(2)d.(4) & prefers higher transfers,it never proposes a transfer (vD+UF) b2<S2.Further,a proposal that raises the transfer to b2>s2 will fail:if Equation (2)holds,FG recognizes A transfer of power from a friendly date-one domestic that DG2 will implement the project even if the initial government DG to a more hostile date-two domestic agreement is not amended.As a result,FG would reject government DG2(i.e.,from to v)carries two implica- the amendment,because a threat by DG,to renege on tions.First,it increases the prospect that DG2 can rene- the inherited agreement is not credible.With residual gotiate the initial terms to a more favorable arrange- probability 1-0,FG gets to propose a modification. ment.Second,it lowers the total surplus of the date-two Although FG would like to negotiate a reduced trans- negotiating parties.As a result,there will be situations fer,DG2 will refuse such amendments-it prefers to in which a hostile DG2 will fail to reach an agreement maintain the existing terms,which offer more favorable with FG in contexts where a more project-friendly DG2 concessions in return for implementing the project. would have successfully concluded the negotiation. Suppose,instead,that DG2 anticipates a negative value from implementing the project at the status-quo Discussion:The bargaining protocol is starker than transfer;that is,Equation(2)fails.This means that it necessary for our main results.What is crucial is that would prefer not to implement the project at date two the terms that the domestic government obtains at date unless the initial terms were amended to a higher trans- two improve as its valuation of the project falls,rela- fer.Suppose,first,that the surplus from agreement is tive to the status quo offer.This improvement in terms positive;that is,Equation(1)holds. holds regardless of the distribution of date-two bar- With probability 0,DG2 gets to propose a modifica- gaining power,6[0,1].When the domestic govern- tion to the inherited terms.If FG rejects the proposal, ment holds date-two proposal power,a more hostile the project will end when Equation(2)does not hold, representative can renegotiate the status quo transfer giving FG a payoff of zero.Thus,DG2 can renegoti- from s2 up to b2 Ur.When,instead,the FG holds pro- ate the date-two transfer from s2 to the larger transfer posal power,its offer holds the date-two domestic gov- b2=vF.That FG is held to its participation constraint ernment to its participation constraint,but its transfer is not essential-what matters is that there is a disconti- b2 =-(vp+)still increases as the domestic govern- nuity in the terms that DG2 can obtain when its threat ment becomes more hostile;that is,as vp decreases.A to break the existing agreement is credible;that is,at more hostile representative not only captures the up- the threshold on A defined in Equation(2).With prob- side of larger concessions-it also mitigates against the ability 1-0.FG is,instead,recognized.Since Equation downside of subsequent appropriation. (2)fails,FG must offer DG2 a larger transfer to secure its participation.It then raises the transfer from s2 to POLICY OUTCOMES AT DATE ONE b2 =-(vp+),leaving DG2 with value vp+A indif- ferent between implementing the project and quitting, Exogenous Power Transitions.In our benchmark set- allowing FG to claim the rest of the surplus for itself. ting,the date-two domestic government's (DG2's) 1022Peter Buisseret and Dan Bernhardt date one, that is, if r1 = 1, then the status quo transfer s2 is the transfer b1 that DG1 accepted. If the project was not implemented, that is, if r1 = 0, then the status quo transfer that serves as the starting point for date-two negotiations is s2 = s1. Because there are no bargaining frictions, the project will be implemented at the terminal date t = 2 if and only if the associated surplus is positive; that is, if and only if v2 D + λ + vF ≥ 0 ⇐⇒ λ ≥ −(v2 D + vF ). (1) Even though the date-two implementation decision does not depend on date-one actions, the division of the surplus depends on (a) the status quo transfer and (b) the shock realization λ. Suppose, first, that DG2 has a high enough project valuation v2 D + λ that it would receive a positive pay￾off from implementing the project when it receives the status-quo transfer s2: v2 D + λ + s2 ≥ 0 ⇐⇒ λ ≥ −(v2 D + s2 ). (2) With probability θ, DG2 is recognized to propose a modification to the inherited terms, s2. Because DG2 prefers higher transfers, it never proposes a transfer b2 < s2. Further, a proposal that raises the transfer to b2 > s2 will fail: if Equation (2) holds, FG recognizes that DG2 will implement the project even if the initial agreement is not amended.As a result, FG would reject the amendment, because a threat by DG2 to renege on the inherited agreement is not credible. With residual probability 1 − θ, FG gets to propose a modification. Although FG would like to negotiate a reduced trans￾fer, DG2 will refuse such amendments—it prefers to maintain the existing terms, which offer more favorable concessions in return for implementing the project. Suppose, instead, that DG2 anticipates a negative value from implementing the project at the status-quo transfer; that is, Equation (2) fails. This means that it would prefer not to implement the project at date two unless the initial terms were amended to a higher trans￾fer. Suppose, first, that the surplus from agreement is positive; that is, Equation (1) holds. With probability θ, DG2 gets to propose a modifica￾tion to the inherited terms. If FG rejects the proposal, the project will end when Equation (2) does not hold, giving FG a payoff of zero. Thus, DG2 can renegoti￾ate the date-two transfer from s2 to the larger transfer b2 = vF . That FG is held to its participation constraint is not essential—what matters is that there is a disconti￾nuity in the terms that DG2 can obtain when its threat to break the existing agreement is credible; that is, at the threshold on λ defined in Equation (2). With prob￾ability 1 − θ, FG is, instead, recognized. Since Equation (2) fails, FG must offer DG2 a larger transfer to secure its participation. It then raises the transfer from s2 to b2 = −(v2 D + λ), leaving DG2 with value v2 D + λ indif￾ferent between implementing the project and quitting, allowing FG to claim the rest of the surplus for itself. Finally, if the date-two surplus from agreement is negative; that is, if Equation (1) does not hold, then no amendment will be agreed upon, as the joint surplus from implementing the project is negative. The project will not be implemented and all agents receive date￾one payoffs of zero. The expected date-two payoff of a domestic agent with date-one project valuation v who anticipates that the DG2 will have project valuation v2 D and face status quo transfer s2 is thus VD(v, v2 D,s2 ) = σ −(v2 D+s2 ) (v + s2 + λ)f(λ) dλ + −(v2 D+s2 ) −(v2 D+vF ) (v − v2 D + θ (v2 D + λ + vF ))f(λ) dλ. (3) The expected date-two project payoff of FG given s2 when it faces DG2 with valuation v2 D is VF (v2 D,s2 ) = σ −(v2 D+s2 ) (vF − s2 )f(λ) dλ + −(v2 D+s2 ) −(v2 D+vF ) (1 − θ )(v2 D + λ + vF )f(λ) dλ. (4) A transfer of power from a friendly date-one domestic government DG1 to a more hostile date-two domestic government DG2 (i.e., from v to v) carries two implica￾tions. First, it increases the prospect that DG2 can rene￾gotiate the initial terms to a more favorable arrange￾ment. Second,it lowers the total surplus of the date-two negotiating parties. As a result, there will be situations in which a hostile DG2 will fail to reach an agreement with FG in contexts where a more project-friendly DG2 would have successfully concluded the negotiation. Discussion: The bargaining protocol is starker than necessary for our main results. What is crucial is that the terms that the domestic government obtains at date two improve as its valuation of the project falls, rela￾tive to the status quo offer. This improvement in terms holds regardless of the distribution of date-two bar￾gaining power, θ ∈ [0, 1]. When the domestic govern￾ment holds date-two proposal power, a more hostile representative can renegotiate the status quo transfer from s2 up to b2 = vF .When, instead, the FG holds pro￾posal power, its offer holds the date-two domestic gov￾ernment to its participation constraint, but its transfer b2 = −(v2 D + λ) still increases as the domestic govern￾ment becomes more hostile; that is, as v2 D decreases. A more hostile representative not only captures the up￾side of larger concessions—it also mitigates against the downside of subsequent appropriation. POLICY OUTCOMES AT DATE ONE Exogenous Power Transitions. In our benchmark set￾ting, the date-two domestic government’s (DG2’s) 1022 Downloaded from https://www.cambridge.org/core. Shanghai JiaoTong University, on 26 Oct 2018 at 03:53:04, subject to the Cambridge Core terms of use, available at https://www.cambridge.org/core/terms. https://doi.org/10.1017/S0003055418000400