Third Parties and Specific Investments

Competitive advantage is typically based on a unique nexus of firm-specific investments that creates inimitable quasi-rents. Because it is impossible to write complete contracts on how to distribute the quasi-rents, stakeholders tend to underinvest in firm-specific assets to avoid the hold-up risk. This paper empirically tests the effect of third-party ownership on specific investments. Third-party ownership assigns the rights of residual control to independent fiduciaries. We conduct variations of the trust game, in which a third party, rather than the receiver, distributes the returns on investments. A randomly chosen third party with a fixed payment induces larger investments over time although the experimental design rules out reputation building. If receivers select the third parties, this benefit vanishes. If the third party receives a reward for the appointment, investments actually decrease. Investors (unwarrantedly) fear lower back transfers in such cases.