IDEAS home Printed from https://ideas.repec.org/p/trf/wpaper/281.html
   My bibliography  Save this paper

Signaling an Outside Option

Author

Listed:
  • Ohlendorf, Susanne
  • Schmitz, Patrick

Abstract

We consider the case of an upstream seller who works to improve an asset that has been specialized to a downstream buyer's needs. The buyer then makes a take it or leave it offer to the seller about how the future surplus should be split. We assume that the seller from the outset has private information about the fraction of the surplus that he can realize on his own, and show that this leads to higher investment compared to the complete information case. This positive effect on investment is countervailed by the occurrence of inefficient separations, which result when the buyer mistakenly tries to call the seller's bluff with a low offer.

Suggested Citation

  • Ohlendorf, Susanne & Schmitz, Patrick, 2009. "Signaling an Outside Option," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 281, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    • Handle: RePEc:trf:wpaper:281
    as

    Download full text from publisher

    File URL: https://epub.ub.uni-muenchen.de/13273/1/281.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-785, July.
    2. Bajari, Patrick & Tadelis, Steven, 2001. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 387-407, Autumn.
    3. Farrell, Joseph & Gibbons, Robert, 1995. "Cheap Talk about Specific Investments," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 11(2), pages 313-334, October.
    4. Gul, Faruk, 2001. "Unobservable Investment and the Hold-Up Problem," Econometrica, Econometric Society, vol. 69(2), pages 343-376, March.
    5. Ilya Segal & Michael D. Whinston, 2002. "The Mirrlees Approach to Mechanism Design with Renegotiation (with Applications to Hold-up and Risk Sharing)," Econometrica, Econometric Society, vol. 70(1), pages 1-45, January.
    6. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(4), pages 1843-1881.
    7. Choné, Philippe & Linnemer, Laurent, 2010. "Optimal litigation strategies with observable case preparation," Games and Economic Behavior, Elsevier, vol. 70(2), pages 271-288, November.
    8. Sloof, Randolph, 2008. "Price-setting power vs. private information: An experimental evaluation of their impact on holdup," European Economic Review, Elsevier, vol. 52(3), pages 469-486, April.
    9. Patrick Gonzàlez, 2004. "Investment and Screening Under Asymmetric Endogenous Information," RAND Journal of Economics, The RAND Corporation, vol. 35(3), pages 502-519, Autumn.
    10. David de Meza & Ben Lockwood, 1998. "Does Asset Ownership Always Motivate Managers? Outside Options and the Property Rights Theory of the Firm," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(2), pages 361-386.
    11. Hermalin, Benjamin E, 1998. "Toward an Economic Theory of Leadership: Leading by Example," American Economic Review, American Economic Association, vol. 88(5), pages 1188-1206, December.
    12. Andrew F. Daughety & Jennifer F. Reinganum, 2009. "Hidden Talents: Entrepreneurship and Pareto‐Improving Private Information," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 18(3), pages 901-934, September.
    13. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 83-114.
    14. Weiss, Andrew, 1983. "A Sorting-cum-Learning Model of Education," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 420-442, June.
    15. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    16. Susanne Ohlendorf, 2009. "Expectation Damages, Divisible Contracts, and Bilateral Investment," American Economic Review, American Economic Association, vol. 99(4), pages 1608-1618, September.
    17. Nöldeke, Georg & Schmidt, Klaus M., 1995. "Option contracts and renegotiation," Munich Reprints in Economics 19329, University of Munich, Department of Economics.
    18. Jullien, Bruno, 2000. "Participation Constraints in Adverse Selection Models," Journal of Economic Theory, Elsevier, vol. 93(1), pages 1-47, July.
    19. Patrick W. Schmitz, 2006. "Information Gathering, Transaction Costs, and the Property Rights Approach," American Economic Review, American Economic Association, vol. 96(1), pages 422-434, March.
    20. Michael D. Whinston, 2003. "On the Transaction Cost Determinants of Vertical Integration," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 19(1), pages 1-23, April.
    21. 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.
    22. Philippe Choné & Laurent Linnemer, 2008. "Optimal Litigation Strategies with Signaling and Screening," CESifo Working Paper Series 2334, CESifo.
    23. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
    24. James M. Malcomson, 1997. "Contracts, Hold-Up, and Labor Markets," Journal of Economic Literature, American Economic Association, vol. 35(4), pages 1916-1957, December.
    25. Chiu, Y Stephen, 1998. "Noncooperative Bargaining, Hostages, and Optimal Asset Ownership," American Economic Review, American Economic Association, vol. 88(4), pages 882-901, September.
    26. 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.
    27. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-460, March.
    28. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, September.
    29. James M. Malcomson, 1997. "Contracts, Hold-Up, and Labor Markets," Journal of Economic Literature, American Economic Association, vol. 35(4), pages 1916-1957, December.
    30. John Moore, 1985. "Optimal Labour Contracts when Workers have a Variety of Privately Observed Reservation Wages," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(1), pages 37-67.
    31. Michael Spence, 1973. "Job Market Signaling," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 87(3), pages 355-374.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Fumitoshi Moriya & Takuro Yamashita, 2020. "Asymmetric‐information allocation to avoid coordination failure," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 29(1), pages 173-186, January.
    2. Schmitz, Patrick W., 2012. "Public goods and the hold-up problem under asymmetric information," Economics Letters, Elsevier, vol. 117(3), pages 642-645.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Goldlücke, Susanne & Schmitz, Patrick W., 2014. "Investments as signals of outside options," Journal of Economic Theory, Elsevier, vol. 150(C), pages 683-708.
    2. Ilya Segal & Michael D.Whinston, 2012. "Property Rights [The Handbook of Organizational Economics]," Introductory Chapters,, Princeton University Press.
    3. Robert Gibbons & John Roberts, 2012. "The Handbook of Organizational Economics," Economics Books, Princeton University Press, edition 1, volume 1, number 9889.
    4. Surajeet Chakravarty & W. Bentley MacLeod, 2004. "On the Efficiency of Standard Contracts the Case of Construction," Working Papers 874, Princeton University, Department of Economics, Industrial Relations Section..
    5. Surajeet Chakravarty & Bentley MacLeod, 2004. "On the Efficiency of Standard Contracts the Case of Construction," Working Papers 874, Princeton University, Department of Economics, Industrial Relations Section..
    6. 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.
    7. Oliver Hart & John Moore, 2004. "Agreeing Now to Agree Later: Contracts that Rule Out but do not Rule In," Edinburgh School of Economics Discussion Paper Series 109, Edinburgh School of Economics, University of Edinburgh.
    8. M'hand Fares, 2006. "Renegotiation Design and Contract Solutions to the Hold‐Up Problem," Journal of Economic Surveys, Wiley Blackwell, vol. 20(5), pages 731-756, December.
    9. Committee, Nobel Prize, 2016. "Oliver Hart and Bengt Holmström: Contract Theory," Nobel Prize in Economics documents 2016-1, Nobel Prize Committee.
    10. Schmitz, Patrick W, 2001. "The Hold-up Problem and Incomplete Contracts: A Survey of Recent Topics in Contract Theory," Bulletin of Economic Research, Wiley Blackwell, vol. 53(1), pages 1-17, January.
    11. Kusterer, David J. & Schmitz, Patrick W., 2017. "The management of innovation: Experimental evidence," Games and Economic Behavior, Elsevier, vol. 104(C), pages 706-725.
    12. Eduard Marinov, 2016. "The 2016 Nobel Prize in Economics," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 97-149.
    13. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, September.
    14. Stephanie Rosenkranz & Patrick W. Schmitz, 2007. "Can Coasean Bargaining Justify Pigouvian Taxation?," Economica, London School of Economics and Political Science, vol. 74(296), pages 573-585, November.
    15. Alan Schwartz, 2004. "The Law and Economics of Costly Contracting," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 20(1), pages 2-31, April.
    16. Schmitz, Patrick W., 2013. "Bargaining position, bargaining power, and the property rights approach," Economics Letters, Elsevier, vol. 119(1), pages 28-31.
    17. Patrick W. Schmitz, 2001. "Partial Privatization and Incomplete Contracts: The Proper Scope of Government Reconsidered," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 57(4), pages 394-411, August.
    18. Gersbach, Hans & Haller, Hans, 2020. "On efficient firm formation," Mathematical Social Sciences, Elsevier, vol. 107(C), pages 1-12.
    19. Schmitz, Patrick W., 2010. "Contractual solutions to hold-up problems with quality uncertainty and unobservable investments," Journal of Mathematical Economics, Elsevier, vol. 46(5), pages 807-816, September.
    20. Alessandro De Chiara, 2018. "Courts' Decisions, Cooperative Investments, and Incomplete Contracts," CEU Working Papers 2018_5, Department of Economics, Central European University.

    More about this item

    Keywords

    signaling; relationship-specific investment; incomplete contracts; outside options;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:trf:wpaper:281. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Tamilla Benkelberg (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.