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Timing of investments, holdup and total welfare

  • Smirnov, Vladimir
  • Wait, Andrew

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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Article provided by Elsevier in its journal International Journal of Industrial Organization.

Volume (Year): 22 (2004)
Issue (Month): 3 (March)
Pages: 413-425

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Handle: RePEc:eee:indorg:v:22:y:2004:i:3:p:413-425
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505551

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  1. Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer.
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  12. 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.
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