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Rigidity in bilateral trade with holdup

  • Zhao, Rui R.

    ()

    (Department of Economics, University at Albany, SUNY)

Registered author(s):

This paper studies bilateral trade in which the seller makes a hidden investment that influences the buyer's hidden valuation. In general it is impossible to implement both first-best efficient trade and efficient investment using budget-balanced trading mechanisms. The paper fully characterizes the constrained efficient contracts. It is shown that the optimal tradeoff between allocative efficiency and incentive provision results in rigidity in trade, the degree of which depends on the seriousness of the holdup problem. Sufficient conditions are also provided for full separation of buyer types to take place in optimal contracts when the holdup problem is not too severe. The seller may overinvest relative to the first best.

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File URL: http://econtheory.org/ojs/index.php/te/article/viewFile/20080085/1638/79
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Article provided by Econometric Society in its journal Theoretical Economics.

Volume (Year): 3 (2008)
Issue (Month): 1 (March)
Pages:

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Handle: RePEc:the:publsh:354
Contact details of provider: Web page: http://econtheory.org

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