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Bargaining under Incomplete Information, Fairness, and the Hold-Up Problem

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  • Siemens, Ferdinand von
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    Abstract

    In the hold-up problem incomplete contracts cause the proceeds of relation specific investments to be allocated by ex-post bargaining. The present paper investigates the efficiency of incomplete contracts if individuals have heterogeneous preferences implying heterogeneous bargaining behavior and - equally important - preferences are private information. As the sunk investment costs can thus potentially signal preferences, they can influence beliefs and consequently bargaining outcomes. The necessities of signalling are shown to generate very strong investment incentives. These incentives are based on the desire not to reveal information that is unfavorable in the ensuing bargaining. After finding all perfect Bayesian equilibria in pure strategies, the paper derives the necessary and sufficient conditions under which it is optimal to invest and trade efficiently.

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    File URL: http://epub.ub.uni-muenchen.de/518/1/IncompleteMunich.pdf
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    Bibliographic Info

    Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 518.

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    Date of creation: Feb 2005
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    Handle: RePEc:lmu:muenec:518

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    Keywords: Incomplete Contracts; Hold-Up; Fairness; Bargaining under Incomplete Information; Signalling;

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    1. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
    2. Tore Ellingsen & Magnus Johannesson, 2004. "Is There a Hold-up Problem?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(3), pages 475-494, October.
    3. Gul, Faruk, 2001. "Unobservable Investment and the Hold-Up Problem," Econometrica, Econometric Society, vol. 69(2), pages 343-76, March.
    4. Grossman, Sanford J. & Hart, Oliver D., 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Scholarly Articles 3450060, Harvard University Department of Economics.
    5. Fehr, Ernst & Schmidt, Klaus M., . "A theory of fairness, competition, and cooperation," Chapters in Economics, University of Munich, Department of Economics.
    6. Christian Ewerhart, . "The Effect of Sunk Costs on the Outcome of Alternating-Offers Bargaining between Inequity-Averse Agents," IEW - Working Papers 203, Institute for Empirical Research in Economics - University of Zurich.
    7. Troger, Thomas, 2002. "Why Sunk Costs Matter for Bargaining Outcomes: An Evolutionary Approach," Journal of Economic Theory, Elsevier, vol. 102(2), pages 375-402, February.
    8. Tore Ellingsen & Jack Robles, 2000. "Does Evolution Solve the Hold-up Problem," Econometric Society World Congress 2000 Contributed Papers 1525, Econometric Society.
    9. Lorne Carmichael & W. Bentley MacLeod, 2003. "Caring About Sunk Costs: A Behavioral Solution to Holdup Problems with Small Stakes," Journal of Law, Economics and Organization, Oxford University Press, vol. 19(1), pages 106-118, April.
    10. Gary E Bolton & Axel Ockenfels, 1997. "A Theory of Equity, Reciprocity, and Competition," Levine's Working Paper Archive 1889, David K. Levine.
    11. Crawford, Vincent P, 1982. "A Theory of Disagreement in Bargaining," Econometrica, Econometric Society, vol. 50(3), pages 607-37, May.
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