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Signaling an Outside Option

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  • 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
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    References listed on IDEAS

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    Cited by:

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    2. Schmitz, Patrick W., 2012. "Public goods and the hold-up problem under asymmetric information," Economics Letters, Elsevier, vol. 117(3), pages 642-645.

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    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

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