Formal Contracts, Relational Contracts, and the Holdup Problem
AbstractWe study the holdup problem in repeated transactions between a seller and a buyer such that the seller makes relation-specific investments in each period. We show that where, under spot transaction, formal contracts have no value because of the cooperative nature of investment, writing a simple fixed-price contract can be valuable under repeated transactions: There is a range of parameter values in which a higher investment can be implemented only if a formal price contract is written and combined with a relational contract. We also show that there are cases in which not writing a formal contract but entirely relying on a relational contract increases the total surplus of the buyer and the seller. The key condition is how the investment affects the renegotiation price in general, and the alternative-use value in particular.
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Bibliographic InfoPaper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1786.
Date of creation: 2006
Date of revision:
holdup problem; formal contract; relational contract; cooperative investment; fixed-price contract; relation-specific investment; renegotiation; repeated transactions; long-term relationships;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-10-07 (All new papers)
- NEP-BEC-2006-10-07 (Business Economics)
- NEP-MAC-2006-10-07 (Macroeconomics)
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