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Contractual Remedies to the Holdup Problem: A Dynamic Perspective

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Abstract

An important theme of modern contract theory is the role contracts play to protect parties from the risk of holdup and thereby encouraging their relationship specific investments. While this perspective has generated valuable insights about various contracts, the underlying models abstract from realistic investment dynamics. We reexamine the role of contracts in a dynamic model that endogenizes the timing of investments and trade. The resulting interaction between bargaining and investment significantly alters the insights learned from static models. We show that contracts that would exacerbate the parties' vulnerability to holdup - rather than those protecting them from the risk of holdup - can be desirable. For this reason, separate ownership of complementary assets can be optimal, an exclusivity agreement can protect the investments of its recipient, trade contracts can be beneficial with a purely cooperative investment, and the property rule can offer a better legal protection against externalities loss than the liability rule, much in contrast to the existing results (based on static models).

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  • Yeon-Koo Che & Jozsef Sakovics, 2004. "Contractual Remedies to the Holdup Problem: A Dynamic Perspective," Edinburgh School of Economics Discussion Paper Series 100, Edinburgh School of Economics, University of Edinburgh.
    • Handle: RePEc:edn:esedps:100
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    Cited by:

    1. Milliou Chrysovalantou, 2008. "Technological Proximity and Exclusive Buyer-Supplier Relationships," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 8(1), pages 1-28, July.
    2. Matthew Ellman, 2006. "Specificity Revisited: The Role of Cross-Investments," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 22(1), pages 234-257, April.
    3. Niko Matouschek & Paolo Ramezzana, 2007. "The Role Of Exclusive Contracts In Facilitating Market Transactions," Journal of Industrial Economics, Wiley Blackwell, vol. 55(2), pages 347-371, June.
    4. Ola Kvaløy, 2007. "Asset Specificity and Vertical Integration," Scandinavian Journal of Economics, Wiley Blackwell, vol. 109(3), pages 551-572, September.
    5. Yeon-Koo Che & Jozsef Sakovics, 2006. "The Hold-up Problem," Edinburgh School of Economics Discussion Paper Series 142, Edinburgh School of Economics, University of Edinburgh.
    6. Matthew Ellman, 2006. "The optimal length of contracts with application to outsourcing," Economics Working Papers 965, Department of Economics and Business, Universitat Pompeu Fabra.
    7. Bar-Isaac, Heski & Gavazza, Alessandro, 2015. "Brokers’ contractual arrangements in the Manhattan residential rental market," Journal of Urban Economics, Elsevier, vol. 86(C), pages 73-82.
    8. Chiara Fumagalli & Massimo Motta & Lars Persson, 2009. "On The Anticompetitive Effect Of Exclusive Dealing When Entry By Merger Is Possible," Journal of Industrial Economics, Wiley Blackwell, vol. 57(4), pages 785-811, December.
    9. Milliou, Chrysovalantou, 2004. "Exclusive dealing and compatibility of investments," UC3M Working papers. Economics we044919, Universidad Carlos III de Madrid. Departamento de Economía.
    10. Watson, Joel, 2006. "Contract and Mechanism Design in Settings with Multi-Period Trade," University of California at San Diego, Economics Working Paper Series qt63s1s3j6, Department of Economics, UC San Diego.
    11. David Meza & Mariano Selvaggi, 2007. "Exclusive contracts foster relationship-specific investment," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 85-97, March.

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