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Incomplete Contracts with Cross-Investments

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  • Guriev Sergei

    ()
    (New Economic School, Moscow)

Abstract

We study an incomplete contract model where both contracting parties can invest, and the investments have both self- and cross-effects. We analyze the performance of non-contingent contracts, message games, option contracts and property rights. We find that the first best is implemented if (i) the cross effects are negative or weaker than self-effects; (ii) the strength of cross-effects relative to self-effects is symmetric across parties. If either of these conditions is violated, even message contingent revelation mechanisms fail to provide efficient incentives. For this case, we obtain a number of results characterizing the second best. We find that property rights outperform contracts and partially relax the symmetry constraint. In either first best or second best, the stronger the cross-effects, the lower the value of contracting. The optimal allocation of property rights assigns ownership to the party with stronger cross-effects.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Theoretical Economics.

Volume (Year): 3 (2003)
Issue (Month): 1 (August)
Pages: 1-32

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Handle: RePEc:bpj:bejtec:v:contributions.3:y:2003:i:1:n:5

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  1. Paul L. Joskow, 1990. "The Performance of Long-Term Contracts: Further Evidence from Coal Markets," RAND Journal of Economics, The RAND Corporation, vol. 21(2), pages 251-274, Summer.
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Citations

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Cited by:
  1. Alexander Stremitzer, 2009. "Standard Breach Remedies, Quality Thresholds, and Cooperative Investments," Bonn Econ Discussion Papers bgse4_2009, University of Bonn, Germany.
  2. Sergei Guriev & Dmitriy Kvasov, 2005. "Contracting on Time," American Economic Review, American Economic Association, vol. 95(5), pages 1369-1385, December.
  3. Schmitz, Patrick W., 2010. "On contractual solutions to hold-up problems with quality uncertainty and unobservable investments," MPRA Paper 23157, University Library of Munich, Germany.
  4. Watson, Joel & Buzard, Kristy, 2009. "Contract, Renegotiation, and Hold Up: General Results on the Technology of Trade and Investment," University of California at San Diego, Economics Working Paper Series qt3923q7kz, Department of Economics, UC San Diego.
  5. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, September.
  6. Schmitz, Patrick W., 2009. "Contractual solutions to hold-up problems with quality uncertainty and unobservable investments," CEPR Discussion Papers 7584, C.E.P.R. Discussion Papers.
  7. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
  8. Schmitz, Patrick W., 2005. "Information Gathering, Transaction Costs and the Property Rights Approach," CEPR Discussion Papers 5417, C.E.P.R. Discussion Papers.
  9. Andreas Roider, 2004. "Asset Ownership and Contractibility of Interaction," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 787-802, Winter.
  10. Watson, Joel & Wignall, Chris, 2009. "Hold-Up and Durable Trading Opportunities," University of California at San Diego, Economics Working Paper Series qt8p8284wg, Department of Economics, UC San Diego.
  11. Buzard, Kristy & Watson, Joel, 2010. "Contract, Renegotiation, and Hold Up: Results on the Technology of Trade and Investment," University of California at San Diego, Economics Working Paper Series qt3df3q4vg, Department of Economics, UC San Diego.
  12. Brooks, Richard & Stremitzer, Alexander, 2009. "On and Off Contract Remedies," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 290, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.

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