Bilateral bargaining, unverifiable quality, and options to return

Summary. The paper investigates an alternating-offers bargaining game between a buyer and a seller who face several trading opportunities. These items (goods or services) differ in their non-verifiable quality characteristics which gives rise to a moral hazard problem on the seller's part. For the special case of two goods, we completely characterize the set of subgame-perfect equilibria. We find that the seller always extends an option to return the good, while the buyer may suffer from this warranty. Also, qualitatively different types of equilibrium outcomes occur depending on the parameters of the model: (a) the seller may obtain a larger share of the surplus although the parties ex ante have symmetric bargaining positions, (b) the subgame-perfect equilibrium may entail inefficient trade, and (c) multiple equilibria may exist including equilibria with delay in negotiations. Finally, we analyze a situation where bargaining proceeds after the good was returned which is shown to reestablish uniqueness and efficiency of equilibrium.Received: 23 August 2001, Revised: 3 April 2003, JEL Classification Numbers: C78, L14, L15, D82. Correspondence to: Christoph LülfesmannThis paper has greatly benefitted from discussions with Avner Shaked and Timothy von Zandt. We also wish to thank Wolfgang Leininger, Zvika Neeman, Clemens Puppe, Wolfram Richter, Karl Schlag, Ilya Segal, and seminar participants in Dortmund, Bonn and Berkeley for helpful comments and discussions. Financial support by Deutsche Forschungsgemeinschaft, SFB 303 at the University of Bonn is gratefully acknowledged.