Bargaining under Asymmetric Information and the Hold-up Problem

The hold-up problem is considered a fundamental determinant of contractual and organizational structure. We study a model in which players first make relation-specific investments and then bargain over the price to exchange a good. We present a new form of misallocation of resources that may arise if one of the sides has private information in the bargaining phase. In general, the outcome of bargaining depends not only on the expected values the sides assign to the transaction but also on the information structure. That may result in agents choosing investment options that ‘increase’ information asymmetry, even though they decrease total surplus. The information rents may also influence investment decision of the player that has all bargaining power ex-post (in the sense of making all offers, which under symmetric information allows him to extract full surplus). This intuition is illustrated in a very simple model in which the seller investment yields stochastic and privately observable cost savings. In the bargaining phase the buyer makes frequent price offers. The bargaining outcomes are driven by Coasian dynamics and allow for a very tractable analysis of the incentives to invest. I acknowledge the financial support of the CEBC. Graduate School of Business, Stanford University, Stanford CA 94305, USA. Email: [email protected].