This paper proposes a model for multilateral contracting, where contracts are written and renegotiated over time, and where contracts may impose externalities on other agents. Equilibria always exist and the equilibrium value function is linear and monotonically increasing on the contracts. If the grand coalition, or contracting among all agents, is inefficient, we show that bargaining delays arise in positive-externality games and equilibrium inefficiency may remain bounded away from zero even as bargaining frictions converge to zero. Otherwise, if the grand coalition is efficient, there are no bargaining delays, convergence to the grand coalition occurs in a finite number of contracting rounds, and the outcome becomes efficient as players become more patient. Copyright The Econometric Society 2005.

An economy with a finite number of agents and a finite number of states is considered. An exogenous institutional rule prescribes which moves from one state to another are feasible to each coalition. At each time, an agent is called to act with some exogenous probability, and he chooses a coalition, a feasible new state to move the economy to, and side payments between the agents in the coalition. The setup can be applied to various dynamic processes of social and economic interactions such as legislative bargaining, coalition formation, or exchange economies. Whenever agents are unable to write long‐term contracts, but are otherwise unconstrained both in their ability to write arbitrary spot contracts and in their ability to collude, there can be long‐run inefficiencies (with cycles or inefficient steady states). However, when agents are sufficiently patient, the initial state from which the process starts plays no role in the long run. Moreover, when there exists an efficient state that is free of negative externalities (in the sense that a move away from that state does not hurt the agents whose consent is not required for the move), the system must converge to this efficient state in the long run. It is thus more important to design institutions guaranteeing the existence of an efficient negative externality–free state than to implement a fine initialization of the process.