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Specificity revisited: The role of cross-investments

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  • Matthew Ellman

Abstract

Previous analysis has shown that traders may opt for specific technologies with no joint productivity advantage as a way to commit themselves to trading jointly, but only when long-term contracting is infeasible. This paper proves that speciÞcity can also be optimal (by relaxing the budget-balance constraint) in settings with long-term contracting. Traders will opt for specificity when one trader makes a cross-investment and either (1) this cross-investment has a direct externality on the other trader, (2) both parties invest, or (3) private information is present. The specificity (e.g. from non- salvageable investments, specific assets and technologies, narrow business strategies, and exclusivity restrictions) is equally effective regardless of which trader's alternative trade payoff is reduced. Specificity supports long-term contracts in a broad range of settings - both with and without renegotiation. The theory also offers a novel perspective on franchising and vertical integration.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 799.

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Date of creation: Nov 2004
Date of revision: Jan 2005
Handle: RePEc:upf:upfgen:799

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Web page: http://www.econ.upf.edu/

Related research

Keywords: Specificity; hostages long-term contracting; cross-investments; budget-balance; renegotiation;

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References

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Citations

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Cited by:
  1. Matthew Ellman, 2006. "The optimal length of contracts with application to outsourcing," Economics Working Papers 965, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Watson, Joel & Buzard, Kristy, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
  3. Maija Halonen-Akatwijuka, 2010. "Organizational Design, Technology and the Boundaries of the Firm," Economica, London School of Economics and Political Science, vol. 77(307), pages 544-564, 07.
  4. Watson, Joel & Wignall, Chris, 2009. "Hold-Up and Durable Trading Opportunities," University of California at San Diego, Economics Working Paper Series qt8p8284wg, Department of Economics, UC San Diego.
  5. Ola Kvaløy & Ragnar Tveter�s, 2008. "Cost Structure and Vertical Integration between Farming and Processing," Journal of Agricultural Economics, Wiley Blackwell, vol. 59(2), pages 296-311, 06.
  6. Watson, Joel & Buzard, Kristy, 2009. "Contract, Renegotiation, and Hold Up: General Results on the Technology of Trade and Investment," University of California at San Diego, Economics Working Paper Series qt3923q7kz, Department of Economics, UC San Diego.
  7. Christian A. Ruzzier, 2009. "Asset Specificity and Vertical Integration: Williamson’s Hypothesis Reconsidered," Harvard Business School Working Papers 09-119, Harvard Business School.

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