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Rigidity in bilateral trade with holdup

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  • Zhao, Rui R.

    () (Department of Economics, University at Albany, SUNY)

Abstract

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.

Suggested Citation

  • Zhao, Rui R., 2008. "Rigidity in bilateral trade with holdup," Theoretical Economics, Econometric Society, vol. 3(1), March.
  • Handle: RePEc:the:publsh:354
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    References listed on IDEAS

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    Cited by:

    1. Yeon-Koo Che & Elisabetta Iossa & Patrick Rey, 2015. "Prizes versus Contracts as Incentives for Innovation," CEIS Research Paper 358, Tor Vergata University, CEIS, revised 22 Oct 2015.
    2. Krähmer, Daniel, 2012. "Auction design with endogenously correlated buyer types," Journal of Economic Theory, Elsevier, vol. 147(1), pages 118-141.
    3. Vasconcelos, Luís, 2014. "Contractual signaling, relationship-specific investment and exclusive agreements," Games and Economic Behavior, Elsevier, vol. 87(C), pages 19-33.
    4. Maria Goltsman, 2011. "Optimal information transmission in a holdup problem," RAND Journal of Economics, RAND Corporation, vol. 42(3), pages 495-526, September.
    5. Kazumi Hori, 2014. "Contracting for Multiple Goods under Asymmetric Information: The Two-goods Case," KIER Working Papers 888, Kyoto University, Institute of Economic Research.

    More about this item

    Keywords

    Bilateral contracting; hidden action and hidden information; holdup problem; nonlinear pricing;

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D20 - Microeconomics - - Production and Organizations - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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