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Timing of Investments, Hold-up and Total Welfare

  • Smirnov, V.
  • Wait, A.

We explore hold-up when trading parties can make specific investments simultaneously or sequentially. With simultaneous investment both investors are held-up. With sequential investment contracting becomes possible after the project has commenced, so the second investor avoids being held-up. If the two investments are independent three effects are identified when comparing the total welfare of the two regimes: sequential investment increases the costs of delay; sequential investment reduces the incentive for the first player to invest; and the sequential regime increases the second player’s incentive to invest. Given this, the (second-best) optimal regime will favour the more important investment. Similarly, if the choice of investment level of an investor is inelastic to the regime adopted, the timing regime adopted should maximise the incentive for the other party to invest. The paper also shows the timing of investment can act as an additional form of hold-up; if they have the option when to invest, a party may choose the regime that does not maximise total welfare.

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Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 808.

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Length: 50 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:mlb:wpaper:808
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  1. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  2. Vladimir Smirnov & Andrew Wait, 2004. "Hold-up and Sequential Specific Investments," RAND Journal of Economics, The RAND Corporation, vol. 35(2), pages 386-400, Summer.
  3. John Sutton, 1986. "Non-Cooperative Bargaining Theory: An Introduction," Review of Economic Studies, Oxford University Press, vol. 53(5), pages 709-724.
  4. De Fraja, Gianni, 1999. "After You Sir. Hold-Up, Direct Externalities, and Sequential Investment," Games and Economic Behavior, Elsevier, vol. 26(1), pages 22-39, January.
  5. Smirnov, V. & Wait, A., 2001. "Timing of Investments, Hold-up and Total Welfare," Department of Economics - Working Papers Series 808, The University of Melbourne.
  6. Ariel Rubinstein, 2010. "Perfect Equilibrium in a Bargaining Model," Levine's Working Paper Archive 252, David K. Levine.
  7. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
  9. Georg Nöldeke & Klaus M. Schmidt, 1992. "Option Contracts and Renegotiation - A Solution to the Hold-Up Problem," Discussion Paper Serie A 417, University of Bonn, Germany, revised Aug 1993.
  10. Che, Yeon-Koo, 2000. "Can a Contract Solve Hold-Up When Investments Have Externalities? A Comment on De Fraja (1999)," Games and Economic Behavior, Elsevier, vol. 33(2), pages 195-205, November.
  11. Darwin V. Neher, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Oxford University Press, vol. 66(2), pages 255-274.
  12. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, vol. 62(2), pages 257-82, March.
  13. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817, December.
  14. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, vol. 83(4), pages 811-37, September.
  15. Anat R. Admati & Motty Perry, 1991. "Joint Projects without Commitment," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 259-276.
  16. 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.
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