Incomplete Contracts, Irreversible Investments and Entry Deterrence

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Incomplete Contracts, Irreversible Investments and Entry Deterrence

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Antonio Nicita ()
Massimiliano Vatiero ()

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Massimiliano Vatiero

Abstract

When renegotiation under incomplete contracts follows the outside option principle, hold-up may occur as the ex-post degree of competition increases on investor’s side. However, under this framework, asset specificity may play the counterintuitive role of an entry deterrence device, thus decreasing the probability of hold-up. Our result contrasts with standard literature in three respects: i) an equilibrium with overinvestment may emerge; ii) the 'intimidating effect' of overinvestment acts as an endogenous enforcement device; iii) a pervasive trade-off may emerge between ex-post efficient entry and ex-ante efficient specific investments

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Paper provided by Department of Economics, University of Siena in its series Department of Economics University of Siena with number 566.

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Date of creation: Aug 2009
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Handle: RePEc:usi:wpaper:566

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Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-09-26 (All new papers)
NEP-CFN-2009-09-26 (Corporate Finance)
NEP-COM-2009-09-26 (Industrial Competition)
NEP-CTA-2009-09-26 (Contract Theory & Applications)
NEP-MIC-2009-09-26 (Microeconomics)
NEP-PKE-2009-09-26 (Post Keynesian Economics)

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Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law & Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
Binmore, Ken & Shaked, Avner & Sutton, John, 1989. "An Outside Option Experiment," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 753-70, November. [Downloadable!] (restricted)
Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
Dixit, Avinash, 1980. "The Role of Investment in Entry-Deterrence," Economic Journal, Royal Economic Society, vol. 90(357), pages 95-106, March. [Downloadable!] (restricted)
Other versions:
- Dixit, Avinash, 1979. "The Role of Investment in Entry-Deterrence," The Warwick Economics Research Paper Series (TWERPS) 140, University of Warwick, Department of Economics.
Kathryn E. Spier & Michael D. Whinston, 1995. "On the Efficiency of Privately Stipulated Damages for Breach of Contract: Entry Barriers, Reliance, and Renegotiation," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 180-202, Summer. [Downloadable!] (restricted)

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