Bilateral contracts with transaction costs

The paper studies bilateral contracting with endogenous property rights. Players engage in costly ex post adjustment of ex ante contract. After ex ante agreement on surplus sharing, players invest irreversibly production. Player costs of altering ex ante contract are transaction costs of three kinds: measurement, information and enforcement costs. Each player chooses an action which incurs transaction costs and influences the actual ex post surplus sharing. When one player chooses the ex ante contract, each player’s equilibrium share increases in his productivity and transaction cost parameters. We address how player investment incentives depend on the interplay between the transaction costs.