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Strategic Shirking in Bilateral Trade

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Abstract

This paper explores a version of the canonical holdup model where agents undertake specific investments prior to their transaction. In this setting, we identify a novel reason for contractual inefficiency. An investing party (here, the seller) may shirk for strategic reasons, in particular, exert an effort so low that subsequent trade becomes inefficient. We first show that under a fixed-price contract which would otherwise be optimal and induce trade, strategic shirking can arise irrespective of the precontracted trade price. We then establish that if strategic shirking arises under a fixed-price contract, no general mechanism exists which restores efficient trade. Finally, we show that the defection issue is more severe when the parties trade after the buyer's valuation was realized, as compared to a scenario where the trade transaction is finalized in a state of uncertainty.

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Bibliographic Info

Paper provided by Department of Economics, Simon Fraser University in its series Discussion Papers with number dp07-21.

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Length: 29
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:sfu:sfudps:dp07-21

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Postal: Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
Phone: (778)782-3508
Fax: (778)782-5944
Web page: http://www.sfu.ca/economics.html
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Postal: Working Paper Coordinator, Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
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Keywords: Bilateral Trade; Hold-Up; Specific Investments; Shirking.;

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  1. Schmitz, Patrick W., 2002. "On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems," MPRA Paper 12531, University Library of Munich, Germany.
  2. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, Econometric Society, vol. 52(2), pages 449-60, March.
  3. Andreas Roider, 2002. "Asset Ownership and Contractability of Interaction," Bonn Econ Discussion Papers, University of Bonn, Germany bgse12_2002, University of Bonn, Germany, revised May 2003.
  4. Georg Nöldeke & Klaus M. Schmidt, 1992. "Option Contracts and Renegotiation - A Solution to the Hold-Up Problem," Discussion Paper Serie A, University of Bonn, Germany 417, University of Bonn, Germany, revised Aug 1993.
  5. Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1863, Harvard - Institute of Economic Research.
  6. Edlin, Aaron S & Reichelstein, Stefan, 1996. "Holdups, Standard Breach Remedies, and Optimal Investment," American Economic Review, American Economic Association, American Economic Association, vol. 86(3), pages 478-501, June.
  7. William P. Rogerson, 1994. "Economic Incentives and the Defense Procurement Process," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 8(4), pages 65-90, Fall.
  8. Aghion, Philippe & Tirole, Jean, 1994. "The Management of Innovation," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(4), pages 1185-1209, November.
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  10. Schmidt, Klaus M., 2003. "Convertible Securities and Venture Capital Finance," Munich Reprints in Economics, University of Munich, Department of Economics 19769, University of Munich, Department of Economics.
  11. Christoph Lulfesmann, 2005. "Wealth Contraints and Option Contracts in Models with Sequential Investments," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 753-770, Winter.
  12. Lerner, Josh & Merges, Robert P, 1998. "The Control of Technology Alliances: An Empirical Analysis of the Biotechnology Industry," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 46(2), pages 125-56, June.
  13. Chung, Tai-Yeong, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(5), pages 1031-42, October.
  14. Klaus M. Schmidt, 2003. "Convertible Securities and Venture Capital Finance," Journal of Finance, American Finance Association, American Finance Association, vol. 58(3), pages 1139-1166, 06.
  15. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, American Economic Association, vol. 89(1), pages 125-147, March.
  16. Aghion, Philippe & Tirole, Jean, 1994. "On the Management of Innovation," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 36, Institut d'Économie Industrielle (IDEI), Toulouse.
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