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Contract, Renegotiation, and Hold Up: General Results on the Technology of Trade and Investment

  • Watson, Joel
  • Buzard, Kristy

This paper examines a class of contractual relationships with specific investment, a non-durable trading opportunity, and renegotiation. FurtheringWatson’s (2007) line of analysis, trade actions are modeled as individual and trade-action-based option contracts are explored. Simple tools are developed for calculating the “punishment values†that determine the sets of implementable post-investment value functions, and two results are proved. The first result establishes that, with ex post renegotiation, constraining parties to use “forcing contracts†(as is implicit in public-action models) implies a strict reduction in the set of implementable value functions. The second result shows that, by using non-forcing contracts, the party without the trade action can be made residual claimant with regard to the investment action. The paper identifies an important distinction, between divided and unified investment and trade actions, that plays an important role in determining whether an efficient outcome is achieved.

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Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number qt3923q7kz.

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Date of creation: 03 Oct 2009
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Handle: RePEc:cdl:ucsdec:qt3923q7kz
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  1. Yeon-Koo Che & József Sákovics, 2004. "A Dynamic Theory of Holdup," Econometrica, Econometric Society, vol. 72(4), pages 1063-1103, 07.
  2. Evans, R., 2006. "Simple Efficient Contracts in Complex Environments," Cambridge Working Papers in Economics 0627, Faculty of Economics, University of Cambridge.
  3. Paul Beaudry & Michel Poitevin, 1995. "Contract Renegotiation: A Simple Framework and Implications for Organization Theory," Canadian Journal of Economics, Canadian Economics Association, vol. 28(2), pages 302-35, May.
  4. Rogerson, William P, 1992. "Contractual Solutions to the Hold-Up Problem," Review of Economic Studies, Wiley Blackwell, vol. 59(4), pages 777-93, October.
  5. Jesse Bull, 2012. "Third-Party Budget Breakers and Side Contracting in Team Production," Economics Bulletin, AccessEcon, vol. 32(3), pages 2606-2614.
  6. Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer.
  7. Thomas P. Lyon & Eric Rasmusen, 2004. "Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem," Working Papers 2004-10, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  8. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-85, July.
  9. Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2003. "Courts of Law and Unforeseen Contingencies," STICERD - Theoretical Economics Paper Series 447, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  10. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, vol. 62(2), pages 257-82, March.
  11. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 115-38, January.
  12. Edlin, Aaron S & Hermalin, Benjamin E, 2000. "Contract Renegotiation and Options in Agency Problems," Journal of Law, Economics and Organization, Oxford University Press, vol. 16(2), pages 395-423, October.
  13. Chung, Tai-Yeong, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," Review of Economic Studies, Wiley Blackwell, vol. 58(5), pages 1031-42, October.
  14. Nöldeke, Georg & Schmidt, Klaus M., 1997. "Sequential Investments and Options to Own," CEPR Discussion Papers 1645, C.E.P.R. Discussion Papers.
  15. Myerson, Roger B., 1982. "Optimal coordination mechanisms in generalized principal-agent problems," Journal of Mathematical Economics, Elsevier, vol. 10(1), pages 67-81, June.
  16. Sabine Böckem & Ulf Schiller, 2008. "Option Contracts in Supply Chains," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 17(1), pages 219-245, 03.
  17. Sandeep Baliga & Tomas Sjöström, 2009. "Contracting with Third Parties," American Economic Journal: Microeconomics, American Economic Association, vol. 1(1), pages 75-100, February.
  18. Guriev Sergei, 2003. "Incomplete Contracts with Cross-Investments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 3(1), pages 1-32, August.
  19. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-60, March.
  20. Matthew Ellman, 2004. "Specificity Revisited: The Role of Cross-Investments," Working Papers 150, Barcelona Graduate School of Economics.
  21. Andreas Roider, 2002. "Asset Ownership and Contractability of Interaction," Bonn Econ Discussion Papers bgse12_2002, University of Bonn, Germany, revised May 2003.
  22. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  23. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  24. 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.
  25. Jesse Bull, 2009. "Third-Party Budget Breakers and Side-Contracting in Team Production," Working Papers 0909, Florida International University, Department of Economics.
  26. Evans, R., 2006. "Mechanism Design with Renegotiation and Costly Messages," Cambridge Working Papers in Economics 0626, Faculty of Economics, University of Cambridge.
  27. Williamson, Oliver E, 1979. "Transaction-Cost Economics: The Governance of Contractural Relations," Journal of Law and Economics, University of Chicago Press, vol. 22(2), pages 233-61, October.
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