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Bargaining, bargaining power and the composition of investment with an outside option

Author

Listed:
  • Bernhardt, Dan

    (Department of Economics, University of Illinois and Department of Economics, University of Warwick)

  • Hwang, Ilwoo

    (Department of Economics, Seoul National University)

  • Krasa, Stefan

    (Department of Economics, University of Illinois)

Abstract

We modify a canonical two-agent bargaining game with investments in a joint project, by allowing agents to also invest in outside options that improve their bargaining positions. Absent outside options, it is well known that equal bargaining power maximizes output. However, this is no longer true when investment in outside options is possible and the joint-project technology exhibits stronger substitutability than Cobb-Douglas. When this is so, equal bargaining power minimizes project output while maximizing total investment in unused outside options. Paradoxically, when inputs are suffciently strong substitutes, starting at equal bargaining power, each agent would gain from reductions in their own bargaining power.

Suggested Citation

  • Bernhardt, Dan & Hwang, Ilwoo & Krasa, Stefan, 2025. "Bargaining, bargaining power and the composition of investment with an outside option," The Warwick Economics Research Paper Series (TWERPS) 1559, University of Warwick, Department of Economics.
    • Handle: RePEc:wrk:warwec:1559
    as

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    File URL: https://warwick.ac.uk/fac/soc/economics/research/workingpapers/2025/twerp_1559-_bernhardt.pdf
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    References listed on IDEAS

    as
    1. William Fuchs & Andrzej Skrzypacz, 2010. "Bargaining with Arrival of New Traders," American Economic Review, American Economic Association, vol. 100(3), pages 802-836, June.
    2. Hwang, Ilwoo & Li, Fei, 2017. "Transparency of outside options in bargaining," Journal of Economic Theory, Elsevier, vol. 167(C), pages 116-147.
    3. Simon Board & Marek Pycia, 2014. "Outside Options and the Failure of the Coase Conjecture," American Economic Review, American Economic Association, vol. 104(2), pages 656-671, February.
    4. Tirole, Jean, 1986. "Procurement and Renegotiation," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 235-259, April.
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    8. de Meza, David & Lockwood, Ben, 2010. "Too much investment? A problem of endogenous outside options," Games and Economic Behavior, Elsevier, vol. 69(2), pages 503-511, July.
    9. Andrew McClellan, 2024. "Dynamic Outside Options and Optimal Negotiation Strategies," American Economic Review, American Economic Association, vol. 114(10), pages 3284-3313, October.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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