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Noncontractible Investments and Reference Points

Author

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  • Oliver Hart

    () (Department of Economics, Harvard University, Littauer 220, Cambridge, MA 02138, USA)

Abstract

We analyze noncontractible investments in a model with shading. A seller can make an investment that affects a buyer’s value. The parties have outside options that depend on asset ownership. When shading is not possible and there is no contract renegotiation, an optimum can be achieved by giving the seller the right to make a take-it-or-leave-it offer. However, with shading, such a contract creates deadweight losses. We show that an optimal contract will limit the seller’s offers, and possibly create ex post inefficiency. Asset ownership can improve matters even if revelation mechanisms are allowed.

Suggested Citation

  • Oliver Hart, 2013. "Noncontractible Investments and Reference Points," Games, MDPI, Open Access Journal, vol. 4(3), pages 1-20, August.
  • Handle: RePEc:gam:jgames:v:4:y:2013:i:3:p:437-456:d:27990
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    References listed on IDEAS

    as
    1. Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
    2. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-1158, December.
    3. Woodruff, Christopher, 2002. "Non-contractible investments and vertical integration in the Mexican footwear industry," International Journal of Industrial Organization, Elsevier, vol. 20(8), pages 1197-1224, October.
    4. 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.
    5. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, Oxford University Press, vol. 127(4), pages 1843-1881.
    6. Philippe Aghion & Richard Holden, 2011. "Incomplete Contracts and the Theory of the Firm: What Have We Learned over the Past 25 Years?," Journal of Economic Perspectives, American Economic Association, vol. 25(2), pages 181-197, Spring.
    7. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 83-114.
    8. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    9. Fabian Herweg & Klaus Schmidt, 2012. "Loss Aversion and Ex Post Inefficient Renegotiation," CESifo Working Paper Series 4031, CESifo Group Munich.
    10. Ernst Fehr & Oliver Hart & Christian Zehnder, 2011. "Contracts as Reference Points--Experimental Evidence," American Economic Review, American Economic Association, vol. 101(2), pages 493-525, April.
    11. Oliver Hart, 2009. "Hold-up, Asset Ownership, and Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 124(1), pages 267-300.
    12. Oliver Hart & Bengt Holmstrom, 2010. "A Theory of Firm Scope," The Quarterly Journal of Economics, Oxford University Press, vol. 125(2), pages 483-513.
    13. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
    14. Francine Lafontaine & Margaret Slade, 2007. "Vertical Integration and Firm Boundaries: The Evidence," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 629-685, September.
    15. Maija Halonen-Akatwijuka & Oliver D. Hart, 2013. "More is Less: Why Parties May Deliberately Write Incomplete Contracts," NBER Working Papers 19001, National Bureau of Economic Research, Inc.
    16. George P. Baker & Thomas N. Hubbard, 2004. "Contractibility and Asset Ownership: On-Board Computers and Governance in U. S. Trucking," The Quarterly Journal of Economics, Oxford University Press, vol. 119(4), pages 1443-1479.
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    Citations

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    Cited by:

    1. Björn Bartling & Ernst Fehr & Klaus M. Schmidt, 2012. "Use and abuse of authority: A behavioral foundation of the employment relation," ECON - Working Papers 098, Department of Economics - University of Zurich.
    2. Mathias Erlei & Wiebke Roß, 2013. "Bounded Rationality as an Essential Component of the Holdup Problem," TUC Working Papers in Economics 0009, Abteilung für Volkswirtschaftslehre, Technische Universität Clausthal (Department of Economics, Technical University Clausthal).
    3. repec:eee:jeborg:v:145:y:2018:i:c:p:176-201 is not listed on IDEAS
    4. James D. Adams & Albert N. Link, 2017. "The Structure and Performance of U.S. Research Joint Ventures: Inferences and Implications from the Advanced Technology Program," NBER Working Papers 23734, National Bureau of Economic Research, Inc.
    5. Schmidt, Klaus, 2017. "The 2016 Nobel Memorial Prize in Contract Theory," Rationality and Competition Discussion Paper Series 19, CRC TRR 190 Rationality and Competition.
    6. Erlei, Mathias & Reinhold, Christian, 2016. "Contracts as reference points—The role of reciprocity effects and signaling effects," Journal of Economic Behavior & Organization, Elsevier, vol. 127(C), pages 133-145.
    7. Agamirova, Maria Å. & Dzagurova, Nataliya B., 2016. "The Legality of Vertical Restraints by the Rule of Reason and the Character of the Specific Investments," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 6, pages 122-137, December.
    8. repec:aea:aecrev:v:107:y:2017:i:7:p:1731-52 is not listed on IDEAS

    More about this item

    Keywords

    incomplete contracts; noncontractible investments; reference points; asset ownership;

    JEL classification:

    • C - Mathematical and Quantitative Methods
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • C71 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Cooperative Games
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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