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Specificity Revisited: The Role of Cross-Investments

  • Matthew Ellman

Previous analysis has shown that traders may opt for specific technologies with no joint productivity advantage as a way to commit themselves to trading jointly, but only when long-term contracting is infeasible. This paper proves that specificity can also be optimal (by relaxing the budget-balance constraint) in settings with long-term contracting. Traders will opt for specificity when one trader makes a cross-investment and either (1) this cross-investment has a direct externality on the other trader, (2) both parties invest, or (3) private information is present. The specificity (e.g. from non-salvageable investments, specific assets and technologies, narrow business strategies, and exclusivity restrictions) is equally effective regardless of which trader's alternative trade payoff is reduced. Specificity supports long-term contracts in a broad range of settings - both with and without renegotiation. The theory also offers a novel perspective on franchising and vertical integration.

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File URL: http://research.barcelonagse.eu/tmp/working_papers/150.pdf
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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 150.

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Date of creation: Nov 2004
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Handle: RePEc:bge:wpaper:150
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