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Crying Over Spilt Milk: Sunk Costs, Fairness Norms and the Hold-Up Problem

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  • Jeffrey Carpenter

    ()

  • Peter Hans Matthews

    ()

Abstract

This paper explores a possible connection between two behavioral anomalies in economics, the observed responsiveness of individual decision-makers to sunk costs, and the apparent failure of backward induction to predict outcomes in experimental bargaining games. In particular, we show that under some conditions, a "sunk cost sensitive" fairness norm can evolve in such environments. Under this norm, a fair distribution allows all parties to recoup whatever each has invested in their relationship before the net surplus is then divided into equal shares. The establishment of such a norm would have important consequences for the hold-up problem, which we characterize in terms of ultimatum bargaining in the presence of an outside option. We then conclude with a brief discussion of the possible labor market implications of our results.

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File URL: http://www.middlebury.edu/services/econ/repec/mdl/ancoec/0312.pdf
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Bibliographic Info

Paper provided by Middlebury College, Department of Economics in its series Middlebury College Working Paper Series with number 0312.

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Length: 21 pages
Date of creation: Jun 2003
Date of revision:
Handle: RePEc:mdl:mdlpap:0312

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Keywords: sunk costs; norms; fairness; trust; hold-up problem; human capital;

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