Equity participations, hold-up, and firm boundaries Preliminary

This paper shows how partial equity participations can solve the hold-up problem: by weakening the bargaining position, they make the hold-up less effective, and thus improve investment and specialization incentives of the other party. With one-sided dependency, a 50% participation gives full efficiency. In the case of bilateral dependency, the unique efficient solution is equivalent to a merger. This basis for determining optimal firm boundaries is essentially one of incentive design, as suggested by Holmström (1999), rather than property rights. The theory also shows how joint ventures can sometimes realize the benefits of equity participations, while avoiding some concurrent problems.