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Barriers to network-specific investment

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Author Info

  • Antoine Martin

    (Federal Reserve Bank of New York)

  • Michael Orlando

Abstract

We examine incentives for network-specific investment and consider the implications for network governance. We model a two-sided market in which participants making payments over a network platform can invest in a technology that reduces the marginal cost of using the platform. A network effect results in multiple equilibria -- either all agents invest and use of the platform is high or no agents invest and use of the platform is low. The high-use equilibrium can be implemented if commitment is feasible. When the platform cannot commit to usage fees, investment in the platform-specific technology will be held-up, thus implementing the low-investment equilibrium. As a result, governance structures necessary to achieve commitment will be preferred to those necessary merely to achieve coordination. For example, mutual ownership by users of a network platform may emerge where users face risk of ex-post renegotiation. Such a governance structure will also be sufficient to avoid low investment attributable to the network effect. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2007.03.001
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 10 (2007)
Issue (Month): 4 (October)
Pages: 705-728

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Handle: RePEc:red:issued:06-205

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Related research

Keywords: Network; Hold-up; Commitment; Two-sided market; Payments;

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References

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  1. Bruno Jullien, 2004. "Two-Sided Markets and Electronic Intermediaries," CESifo Working Paper Series 1345, CESifo Group Munich.
  2. Michael Kurth, 1985. "Review," Public Choice, Springer, vol. 45(2), pages 223-224, January.
  3. Joseph Farrell & Garth Saloner, 1984. "Standardization, Compatibility and Innovation," Working papers 345, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
  5. James McAndrews & Zhu Wang, 2007. "Microfoundations of Two-sided Markets: The Payment Card Example," DNB Working Papers 128, Netherlands Central Bank, Research Department.
  6. Cardillo, Matthew & Martin, Antoine & Orland0, Michael, 2004. "Innovation on networks: Coordination, governance, and the case of VISA," Journal of Financial Transformation, Capco Institute, vol. 12, pages 104-106.
  7. repec:rje:randje:v:37:y:2006:3:p:668-691 is not listed on IDEAS
  8. Katz, Michael L & Shapiro, Carl, 1985. "Network Externalities, Competition, and Compatibility," American Economic Review, American Economic Association, vol. 75(3), pages 424-40, June.
  9. Klein, Benjamin, 1988. "Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 199-213, Spring.
  10. repec:rje:randje:v:37:y:2006:3:p:720-737 is not listed on IDEAS
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