Contractual Remedies to the Holdup Problem: A Dynamic Perspective
نویسندگان
چکیده
An important theme of modern contract theory is the role contracts play to protect parties from the risk of holdup and thereby encouraging their relationship specific investments. While this perspective has generated valuable insights about various contracts, the underlying models abstract from realistic investment dynamics. We reexamine the role of contracts in a dynamic model that endogenizes the timing of investments and trade. The resulting interaction between bargaining and investment significantly alters the insights learned from static models. We show that contracts that would exacerbate the parties’ vulnerability to holdup — rather than those protecting them from the risk of holdup — can be desirable. Specifically, separate ownership of complementary assets can be optimal, an exclusivity agreement can protect the investments of its recipient, and trade contracts can be beneficial with a purely cooperative investment, much in contrast to the existing results (based on static models). ∗Department of Economics, University of Wisconsin-Madison. †Edinburgh School of Economics, University of Edinburgh. Both authors are grateful for comments from Ian Ayres, Kyle Bagwell, Paul Milgrom, John Moore, Michael Riordan, Alan Schwartz, Jonathan Thomas and the seminar participants at the Universities of Amsterdam (CREED), Arizona, Edinburgh, Florida, UCLA, and Boston, Columbia, Duke, Northwestern (Kellogg School of Management), Ohio State, Vanderbilt Universities, and the 2003 SITE conference. The first author wishes to acknowledge financial support from the National Science Foundation (SES-0319061).
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