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

  • Buzard, Kristy
  • Watson, Joel

This paper examines a class of contractual relationships with specific investment, a non-durable trading opportunity, and renegotiation. Trade actions are modeled as individual and trade-action-based option contracts (“non-forcing contractsâ€) are explored. The paper identifies an important distinction, between divided and unified investment and trade actions, that plays a key role in determining whether efficient investment and trade can be achieved. By using non-forcing contracts, the party without the trade action can be made residual claimant with regard to the investment action, which implies that an efficient outcome can be achieved in the divided case but not typically in the unified case. More generally, the paper shows that, with ex post renegotiation, constraining parties to use “forcing contracts†implies a strict reduction in the set of implementable value functions. Tools are developed for calculating the “punishment values†that determine the sets of implementable post-investment value functions.

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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 qt3df3q4vg.

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Date of creation: 19 Jun 2010
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Handle: RePEc:cdl:ucsdec:qt3df3q4vg
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  1. Evans, R., 2006. "Mechanism Design with Renegotiation and Costly Messages," Cambridge Working Papers in Economics 0626, Faculty of Economics, University of Cambridge.
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  10. Evans, R., 2006. "Simple Efficient Contracts in Complex Environments," Cambridge Working Papers in Economics 0627, Faculty of Economics, University of Cambridge.
  11. 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.
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  15. 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.
  16. repec:fiu:wpaper:0909 is not listed on IDEAS
  17. 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.
  18. Matthew Ellman, 2006. "Specificity Revisited: The Role of Cross-Investments," Journal of Law, Economics and Organization, Oxford University Press, vol. 22(1), pages 234-257, April.
  19. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
  20. Stremitzer, Alexander, 2008. "Standard Breach Remedies, Quality Thresholds, and Cooperative Investments," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 242, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
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  23. Yeon-Koo Che & Jozsef Sakovics, 2004. "A Dynamic Theory of Holdup," ESE Discussion Papers 74, Edinburgh School of Economics, University of Edinburgh.
  24. Thomas P. Lyon, 2004. "Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem," Journal of Law, Economics and Organization, Oxford University Press, vol. 20(1), pages 148-169, April.
  25. 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.
  26. Sandeep Baliga & Tomas Sjostrom, 2005. "Contracting with Third Parties," Levine's Bibliography 784828000000000408, UCLA Department of Economics.
  27. Guriev Sergei, 2003. "Incomplete Contracts with Cross-Investments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 3(1), pages 1-32, August.
  28. Leonid Hurwicz, 1994. "Economic design, adjustment processes, mechanisms, and institutions," Review of Economic Design, Springer, vol. 1(1), pages 1-14, December.
  29. Myerson, Roger B., 1982. "Optimal coordination mechanisms in generalized principal-agent problems," Journal of Mathematical Economics, Elsevier, vol. 10(1), pages 67-81, June.
  30. Rogerson, William P, 1992. "Contractual Solutions to the Hold-Up Problem," Review of Economic Studies, Wiley Blackwell, vol. 59(4), pages 777-93, October.
  31. Chung, Tai-Yeong, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," Review of Economic Studies, Wiley Blackwell, vol. 58(5), pages 1031-42, October.
  32. Joel S. Demski & David E.M. Sappington, 1991. "Resolving Double Moral Hazard Problems with Buyout Agreements," RAND Journal of Economics, The RAND Corporation, vol. 22(2), pages 232-240, Summer.
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