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Barriers to network-specific investment

  • Antoine Martin

    (Federal Reserve Bank of New York)

  • Michael Orlando

We examine incentives for network-specific investment and consider the implications for network governance. We model a two-sided market in which participants making payments over a network platform can invest in a technology that reduces the marginal cost of using the platform. A network effect results in multiple equilibria -- either all agents invest and use of the platform is high or no agents invest and use of the platform is low. The high-use equilibrium can be implemented if commitment is feasible. When the platform cannot commit to usage fees, investment in the platform-specific technology will be held-up, thus implementing the low-investment equilibrium. As a result, governance structures necessary to achieve commitment will be preferred to those necessary merely to achieve coordination. For example, mutual ownership by users of a network platform may emerge where users face risk of ex-post renegotiation. Such a governance structure will also be sufficient to avoid low investment attributable to the network effect. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2007.03.001
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 10 (2007)
Issue (Month): 4 (October)
Pages: 705-728

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Handle: RePEc:red:issued:06-205
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  1. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  8. Klein, Benjamin, 1988. "Vertical Integration as Organizational Ownership: The Fisher Body-General Motors Relationship Revisited," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 199-213, Spring.
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  10. Cardillo, Matthew & Martin, Antoine & Orland0, Michael, 2004. "Innovation on networks: Coordination, governance, and the case of VISA," Journal of Financial Transformation, Capco Institute, vol. 12, pages 104-106.
  11. Bruno Jullien, 2004. "Two-Sided Markets and Electronic Intermediaries," CESifo Working Paper Series 1345, CESifo Group Munich.
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