The Effect of Sunk Costs on the Outcome of Alternating-Offers Bargaining between Inequity-Averse Agents
The paper analyzes the infinite-horizon alternating-offers bargaining game between agents with inequity-averse preferences. Without prior investments, the model predicts a shift of the outcome towards equal division. Asymmetric investments affect the ex-post bargaining outcome, giving an advantage to the party that contributed more. Under suitable circumstances, this effect may significantly mitigate the hold-up problem. In fact, in a symmetric setup, if production is sufficiently profitable, and parties are sufficiently patient, then the first-best investment levels can be approximated without a contract.
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