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Hold-up and Sequential Specific Investments

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  • Smirnov, V.
  • Wait, A.

Abstract

We explore the hold-up problem when trading parties can make specific investments simultaneously or sequentially. As previously emphasized in the literature, sequencing of investments can allow some projects to proceed that would not be feasible with a simultaneous regime. This is not always the case, however. A cost of sequencing investment is that it can disadvantage some parties, reducing their incentive to invest. The mere possibility of sequential investment can be detrimental to welfare; it can even prevent trade from occurring. This is a new result: it allows the choice about the timing of investment to be interpreted as a new form of hold-up. We also examine an investment game in which both parties would prefer to invest second (follow) rather than lead. This game displays some interesting dynamics. As the the number of potential investment periods is increased, the subgame perfect equilibrium can switch between a prisoners’ dilemma and a coordination game.

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Bibliographic Info

Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 807.

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Length: 31 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:mlb:wpaper:807

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Keywords: TRADE ; INVESTMENTS ; GAMES;

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References

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  1. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  2. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-85, July.
  3. Smirnov, V. & Wait, A., 2001. "Timing of Investments, Hold-up and Total Welfare," Department of Economics - Working Papers Series 808, The University of Melbourne.
  4. 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.
  5. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 115-38, January.
  6. De Fraja, Gianni, 1999. "After You Sir. Hold-Up, Direct Externalities, and Sequential Investment," Games and Economic Behavior, Elsevier, vol. 26(1), pages 22-39, January.
  7. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817, September.
  8. Neher, Darwin V, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Wiley Blackwell, vol. 66(2), pages 255-74, April.
  9. Admati, Anat R & Perry, Motty, 1991. "Joint Projects without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 259-76, April.
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Cited by:
  1. Chen, Bin R. & Chiu, Y. Stephen, 2010. "Public-private partnerships: Task interdependence and contractibility," International Journal of Industrial Organization, Elsevier, vol. 28(6), pages 591-603, November.
  2. Thomas Ehrmann & Karl-Hans Hartwig & Torsten Marner & Hendrik Schmale, 2009. "Specific Investments and Ownership Structures in Railways – An Experimental Analysis," Working Papers 12, Institute of Transport Economics, University of Muenster.
  3. Maxim Mai & Vladimir Smirnov & Andrew Wait, 2014. "Ownership, Access, and Sequential Investment," Canadian Journal of Economics, Canadian Economics Association, vol. 47(1), pages 203-231, February.
  4. Smirnov, Vladimir & Wait, Andrew, 2004. "Timing of investments, holdup and total welfare," International Journal of Industrial Organization, Elsevier, vol. 22(3), pages 413-425, March.
  5. AGRELL, Per & KASPERZEC, Roman, 2010. "Dynamic joint investments in supply chains under information asymmetry," CORE Discussion Papers 2010085, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).

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