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Ambivalent Investment and the Hold-Up Problem

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  • Sönje Reiche

Abstract

In this paper we add to the foundations of incomplete contracting literature. We study the hold-up problem with ambivalent investment, where investment benefits the investing party if ex post the right decision is undertaken but harms the investing party if the wrong decision is made. In this context, we show that the power of contracts to provide investment incentives depends on three factors: the commitment value of contracts, the amount of quasirents that the investing party can expect in the case of out-of-contract renegotiation, and the degree of ambivalence of investment. First, contracts provide first-best investment incentives when parties can commit to a contract regardless of the type of investment. Second, with sufficiently ambivalent investment, if parties cannot commit not torenegotiate a contract and if the investing party's bargaining power is intermediate, contracts cannot improve investment incentives above those provided by no contract. In contrast, a simple buyer or seller option contract is optimal when the investing party's bargaining power is extreme. (JEL: D23, K12, L22) (c) 2006 by the European Economic Association.

Suggested Citation

  • Sönje Reiche, 2006. "Ambivalent Investment and the Hold-Up Problem," Journal of the European Economic Association, MIT Press, vol. 4(6), pages 1148-1164, December.
  • Handle: RePEc:tpr:jeurec:v:4:y:2006:i:6:p:1148-1164
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    Cited by:

    1. James E. Rauch & Joel Watson, 2015. "Client-Based Entrepreneurship," Journal of Law, Economics, and Organization, Oxford University Press, vol. 31(1), pages 30-60.
    2. Watson, Joel & Buzard, Kristy, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
    3. Watson, Joel & Buzard, Kristy, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
    4. Evans, Robert & Reiche, Sönje, 2015. "Contract design and non-cooperative renegotiation," Journal of Economic Theory, Elsevier, vol. 157(C), pages 1159-1187.
    5. 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.

    More about this item

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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