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Timing of Investments, Hold-up and Total Welfare

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  • Smirnov, V.
  • Wait, A.

Abstract

We explore hold-up when trading parties can make specific investments simultaneously or sequentially. With simultaneous investment both investors are held-up. With sequential investment contracting becomes possible after the project has commenced, so the second investor avoids being held-up. If the two investments are independent three effects are identified when comparing the total welfare of the two regimes: sequential investment increases the costs of delay; sequential investment reduces the incentive for the first player to invest; and the sequential regime increases the second player’s incentive to invest. Given this, the (second-best) optimal regime will favour the more important investment. Similarly, if the choice of investment level of an investor is inelastic to the regime adopted, the timing regime adopted should maximise the incentive for the other party to invest. The paper also shows the timing of investment can act as an additional form of hold-up; if they have the option when to invest, a party may choose the regime that does not maximise total welfare.

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Bibliographic Info

Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 808.

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Length: 50 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:mlb:wpaper:808

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Keywords: INVESTMENTS ; COSTS ; GAMES;

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References

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  1. Che, Yeon-Koo, 2000. "Can a Contract Solve Hold-Up When Investments Have Externalities? A Comment on De Fraja (1999)," Games and Economic Behavior, Elsevier, vol. 33(2), pages 195-205, November.
  2. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
  3. Ariel Rubinstein, 2010. "Perfect Equilibrium in a Bargaining Model," Levine's Working Paper Archive 661465000000000387, David K. Levine.
  4. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  5. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
  6. Hardman Moore, John & Hart, Oliver, 1985. "Incomplete Contracts and Renegotiation," CEPR Discussion Papers 60, C.E.P.R. Discussion Papers.
  7. Neher, Darwin V, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Wiley Blackwell, vol. 66(2), pages 255-74, April.
  8. 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.
  9. Sutton, John, 1986. "Non-cooperative Bargaining Theory: An Introduction," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 709-24, October.
  10. 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.
  11. Admati, Anat R & Perry, Motty, 1991. "Joint Projects without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 259-76, April.
  12. Smirnov, V. & Wait, A., 2001. "Hold-up and Sequential Specific Investments," Department of Economics - Working Papers Series 807, The University of Melbourne.
  13. Mathias Dewatripont & Philippe Aghion & Patrick Rey, 1994. "Renegotiation design with unverifiable information," ULB Institutional Repository 2013/9591, ULB -- Universite Libre de Bruxelles.
  14. Nöldeke, Georg & Schmidt, Klaus M., 1995. "Option contracts and renegotiation: A solution to the Hold-Up Problem," Munich Reprints in Economics 19329, University of Munich, Department of Economics.
  15. 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. Vladimir Smirnov & Andrew Wait, 2004. "Hold-up and Sequential Specific Investments," RAND Journal of Economics, The RAND Corporation, vol. 35(2), pages 386-400, Summer.
  2. Smirnov, V. & Wait, A., 2001. "Timing of Investments, Hold-up and Total Welfare," Department of Economics - Working Papers Series 808, The University of Melbourne.
  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. Ngo Van Long & Antoine Soubeyran & Raphael Soubeyran, 2012. "Knowledge Accumulation within an Organization," Working Papers 12-03, LAMETA, Universtiy of Montpellier, revised Jan 2012.
  5. Swinnen, Johan F.M. & Vercammen, James, 2006. "Uncertainty and Specific Investment with Weak Contract Enforcement," 2006 Annual meeting, July 23-26, Long Beach, CA 21044, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  6. 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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