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Contracting still matters! Or: How to design a letter of intent

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  • Evelyn Korn

    ()
    (Philipps-University Marburg)

  • Stephan Meisenzahl

    ()
    (Philipps-University Marburg)

Abstract

Any cooperation that profits from relation-specific investments suffers from the well-known hold-up problem. If investments are not enforceable by an outside authority, the gains fall prey to individual opportunism caused by a free-rider problem. If, in addition, individual investments exhibit positive cross effects, Che and Hausch (1999) provide a negative result and show that contracts cannot overcome the hold up due to a lack of verifiable commitment. This paper develops a mechanism that provides such a commitment device: (1) It introduces an acknowledgement game that procures reliable. (2) It embeds the original contracting problem into two institutional designs - a market based one and a private design - that support enforcement. These two devices reestablish efficient investments as enforceable results of a contract.

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File URL: http://www.uni-marburg.de/fb02/makro/forschung/magkspapers/09-2009_korn.pdf
File Function: First version, 2009
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Bibliographic Info

Paper provided by Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) in its series MAGKS Papers on Economics with number 200909.

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Length: 40 pages
Date of creation: 2009
Date of revision:
Publication status: Forthcoming in
Handle: RePEc:mar:magkse:200909

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  26. Hermalin, Benjamin E & Katz, Michael L, 1993. "Judicial Modification of Contracts between Sophisticated Parties: A More Complete View of Incomplete Contracts and Their Breach," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(2), pages 230-55, October.
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