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Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem

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  • Thomas P. Lyon

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

  • Eric Rasmusen

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

“Buyer option” contracts, in which the buyer selects the product variant to be traded and chooses whether to accept delivery, are often used to solve hold-up problems. We present a simple game that focusses sharply on subgames in which the buyer proposes inefficient actions in order to improve his bargaining position. We argue for one of several alternative ways to model this situation. We then apply that modeling choice to recent models of the foundations of incomplete contracts and show that a buyer option contract is sufficient to induce first-best outcomes.

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File URL: http://www.bus.indiana.edu/riharbau/RePEc/iuk/wpaper/bepp2004-10-lyon-rasmusen.pdf
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Bibliographic Info

Paper provided by Indiana University, Kelley School of Business, Department of Business Economics and Public Policy in its series Working Papers with number 2004-10.

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Date of creation: 2004
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Publication status: Published in Journal of Law Economics and Organization, 2004
Handle: RePEc:iuk:wpaper:2004-10

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References

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  1. Joel Watson, 2007. "Contract, Mechanism Design, and Technological Detail," Econometrica, Econometric Society, Econometric Society, vol. 75(1), pages 55-81, 01.
  2. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
  3. Rubinstein, Ariel, 1982. "Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, Econometric Society, vol. 50(1), pages 97-109, January.
  4. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, Econometric Society, vol. 18(2), pages 155-162, April.
  5. Ayres, Ian & Madison, Kristin, 2000. "Threatening inefficient performance," European Economic Review, Elsevier, vol. 44(4-6), pages 818-828, May.
  6. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, Econometric Society, vol. 67(4), pages 741-782, July.
  7. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, Econometric Society, vol. 62(2), pages 257-82, March.
  8. Eric Maskin, 2001. "On Indescribable Contingencies and Incomplete Contracts," Economics Working Papers 0008, Institute for Advanced Study, School of Social Science.
  9. Lyon, Thomas P & Huang, Haizhou, 2002. "Legal Remedies for Breach of the Regulatory "Contract."," Journal of Regulatory Economics, Springer, vol. 22(2), pages 107-32, September.
  10. Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer.
  11. Edlin, Aaron S & Hermalin, Benjamin E, 2000. "Contract Renegotiation and Options in Agency Problems," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 16(2), pages 395-423, October.
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  14. 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.
  15. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  16. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 83-114, January.
  17. Sutton, John, 1986. "Non-cooperative Bargaining Theory: An Introduction," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 53(5), pages 709-24, October.
  18. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
  19. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, vol. 83(4), pages 811-37, September.
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Citations

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Cited by:
  1. Zvika Neeman & Gregory Pavlov, 2010. "Renegotiation-proof Mechanism Design," UWO Department of Economics Working Papers, University of Western Ontario, Department of Economics 20101, University of Western Ontario, Department of Economics.
  2. Antonio Nicita & Massimiliano Vatiero, 2014. "Dixit versus Williamson: the ‘fundamental transformation’ reconsidered," European Journal of Law and Economics, Springer, vol. 37(3), pages 439-453, June.
  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. Bernhard Ganglmair & Luke M. Froeb & Gregory J. Werden, 2012. "Patent Hold-Up and Antitrust: How A Well-Intentioned Rule Could Retard Innovation," Journal of Industrial Economics, Wiley Blackwell, vol. 60(2), pages 249-273, 06.
  5. Watson, Joel & Buzard, Kristy, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, Econometric Society, vol. 7(2), May.
  6. Matthew Ellman, 2004. "Specificity Revisited: The Role of Cross-Investments," Working Papers 150, Barcelona Graduate School of Economics.
  7. Watson, Joel, 2006. "Contract, Mechanism Design, and Technological Detail," University of California at San Diego, Economics Working Paper Series qt2m08n7cg, Department of Economics, UC San Diego.
  8. Thomas P. Lyon & John W. Maxwell, 2012. "Self-Regulation, Negotiated Agreements and Social Welfare," Working Papers, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy 2012-11, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  9. Schmitz, Patrick W., 2010. "Contractual solutions to hold-up problems with quality uncertainty and unobservable investments," Journal of Mathematical Economics, Elsevier, vol. 46(5), pages 807-816, September.
  10. Göller, Daniel & Stremitzer, Alexander, 2009. "Breach Remedies Including Hybrid Investments," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 282, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  11. 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.
  12. Hoppe, Eva I. & Schmitz, Patrick W., 2009. "Can Contracts Solve the Hold-Up Problem? Experimental Evidence," CEPR Discussion Papers 7205, C.E.P.R. Discussion Papers.
  13. 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.
  14. Antonio Nicita & Massimiliamo Vatiro, 2008. "Incomplete Contracts, Property Rights and Endogenous Outside Options," Department of Economics University of Siena, Department of Economics, University of Siena 545, Department of Economics, University of Siena.
  15. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
  16. Schmitz, Patrick W., 2006. "Book Review of “Contract Theory” (Bolton and Dewatripont, 2005)," MPRA Paper 6977, University Library of Munich, Germany.

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