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Contract, renegotiation, and hold up: Results on the technology of trade and investment

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  • Watson, Joel

    ()
    (Department of Economics, University of California, San Diego)

  • Buzard, Kristy

    ()
    (Department of Economics, University of California, San Diego)

Abstract

This paper examines a class of contractual relationships with specific investment, a non-durable trading opportunity, and renegotiation. Trade actions are modeled as individual and trade-action-based option contracts ("non-forcing contracts") are explored. The paper introduces the distinction between divided and unified investment and trade actions, and it shows the key role this distinction plays in determining whether efficient investment and trade can be achieved. Under a non-forcing dual-option contract, the party without the trade action is made residual claimant with regard to the investment action, which induces efficient investment in the divided case. The unified case is more problematic; here, efficiency is typically not attainable but the dual-option contract is still optimal in a wide class of settings. More generally, the paper shows that, with ex post renegotiation, constraining parties to use "forcing contracts" implies a strict reduction in the set of implementable value functions.

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Bibliographic Info

Article provided by Econometric Society in its journal Theoretical Economics.

Volume (Year): 7 (2012)
Issue (Month): 2 (May)
Pages:

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Handle: RePEc:the:publsh:818

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Web page: http://econtheory.org

Related research

Keywords: Contract; renegotiation; hold up; forcing contracts; non-forcing contracts; specific investment; technology of trade; mechanism design;

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References

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  1. Alexander Stremitzer, 2009. "Standard Breach Remedies, Quality Thresholds, and Cooperative Investments," Bonn Econ Discussion Papers bgse4_2009, University of Bonn, Germany.
  2. Georg Nöldeke & Klaus M. Schmidt, 1992. "Option Contracts and Renegotiation - A Solution to the Hold-Up Problem," Discussion Paper Serie A 417, University of Bonn, Germany, revised Aug 1993.
  3. Matthew Ellman, 2004. "Specificity revisited: The role of cross-investments," Economics Working Papers 799, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2005.
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  18. Thomas P. Lyon, 2004. "Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem," Journal of Law, Economics and Organization, Oxford University Press, vol. 20(1), pages 148-169, April.
  19. Guriev Sergei, 2003. "Incomplete Contracts with Cross-Investments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 3(1), pages 1-32, August.
  20. Edlin, Aaron S & Reichelstein, Stefan, 1996. "Holdups, Standard Breach Remedies, and Optimal Investment," American Economic Review, American Economic Association, vol. 86(3), pages 478-501, June.
  21. Evans, R., 2006. "Mechanism Design with Renegotiation and Costly Messages," Cambridge Working Papers in Economics 0626, Faculty of Economics, University of Cambridge.
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  23. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  24. Leonid Hurwicz, 1994. "Economic design, adjustment processes, mechanisms, and institutions," Review of Economic Design, Springer, vol. 1(1), pages 1-14, December.
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