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Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem

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  • Thomas P. Lyon

Abstract

"Buyer-option" contracts, in which the buyer selects the product variant to be traded and chooses whether to accept delivery, are often used to solve holdup problems. We present a simple game that focuses sharply on subgames in which the buyer proposes inefficient actions in order to improve his bargaining position. We argue for one of several alternative ways to model this situation. We then apply that modeling choice to recent models of the foundations of incomplete contracts and show that a buyer-option contract is sufficient to induce first-best outcomes. Copyright 2004, Oxford University Press.

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  • Thomas P. Lyon, 2004. "Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem," Journal of Law, Economics, and Organization, Oxford University Press, vol. 20(1), pages 148-169, April.
  • Handle: RePEc:oup:jleorg:v:20:y:2004:i:1:p:148-169
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    References listed on IDEAS

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    1. Rubinstein, Ariel, 1982. "Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, vol. 50(1), pages 97-109, January.
    2. Joel Watson, 2007. "Contract, Mechanism Design, and Technological Detail," Econometrica, Econometric Society, vol. 75(1), pages 55-81, January.
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    Cited by:

    1. Antonio Nicita & Massimiliano Vatiero, 2014. "Dixit versus Williamson: the ‘fundamental transformation’ reconsidered," European Journal of Law and Economics, Springer, vol. 37(3), pages 439-453, June.
    2. Buzard, Kristy & Watson, Joel, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
    3. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
    4. Oliver Hart & John Moore, 2004. "Agreeing Now to Agree Later: Contracts that Rule Out but do not Rule In," ESE Discussion Papers 109, Edinburgh School of Economics, University of Edinburgh.
    5. Schmitz, Patrick W., 2010. "Contractual solutions to hold-up problems with quality uncertainty and unobservable investments," Journal of Mathematical Economics, Elsevier, vol. 46(5), pages 807-816, September.
    6. Buzard, Kristy & Watson, Joel, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
    7. 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.
    8. Matthew Ellman, 2006. "Specificity Revisited: The Role of Cross-Investments," Journal of Law, Economics, and Organization, Oxford University Press, vol. 22(1), pages 234-257, April.
    9. Zvika Neeman & Gregory Pavlov, 2010. "Renegotiation-proof Mechanism Design," UWO Department of Economics Working Papers 20101, University of Western Ontario, Department of Economics.
    10. Joel Watson, 2007. "Contract, Mechanism Design, and Technological Detail," Econometrica, Econometric Society, vol. 75(1), pages 55-81, January.
    11. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, September.
    12. Thomas P. Lyon & John W. Maxwell, 2012. "Self-Regulation, Negotiated Agreements and Social Welfare," Working Papers 2012-11, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    13. Schmitz, Patrick W., 2006. "Book Review of “Contract Theory” (Bolton and Dewatripont, 2005)," MPRA Paper 6977, University Library of Munich, Germany.
    14. Neeman, Zvika & Pavlov, Gregory, 2008. "Renegotiation-Proof Mechanism Design," Foerder Institute for Economic Research Working Papers 275717, Tel-Aviv University > Foerder Institute for Economic Research.
    15. Göller, Daniel & Stremitzer, Alexander, 2009. "Breach Remedies Including Hybrid Investments," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 282, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    16. Schmitz, Patrick W., 2010. "On contractual solutions to hold-up problems with quality uncertainty and unobservable investments," MPRA Paper 23157, University Library of Munich, Germany.
    17. Antonio Nicita & Massimiliamo Vatiro, 2008. "Incomplete Contracts, Property Rights and Endogenous Outside Options," Department of Economics University of Siena 545, Department of Economics, University of Siena.
    18. Bernhard Ganglmair & Luke M. Froeb & Gregory J. Werden, 2012. "Patent Hold-Up and Antitrust: How A Well-Intentioned Rule Could Retard Innovation," Journal of Industrial Economics, Wiley Blackwell, vol. 60(2), pages 249-273, June.

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