Holdups and overinvestment in capital markets

This paper analyzes the problem of …rms that need to make investment decisions in capital markets characterized by trading frictions and ex-post bargaining. Trading frictions make switching from one capital supplier to another costly, thus implying that the match between …rms and suppliers generates surplus. Ex-post bargaining implies that suppliers can appropriate part of this surplus. Firms react strategically to the resulting holdup problem by overinvesting so as to reduce their marginal productivity and thus the negotiated price of capital. In a multifactor setting, the holdup problem in capital markets interacts with holdup problems in labor markets that typically lead to underinvestment and overemployment. This presents …rms with a trade-o¤ that has non-trivial equilibrium e¤ects and that –depending on the substitutability of capital and labor and the …rm’s bargaining power in each market – can neutralize or exacerbate the distortionary e¤ects each of the holdup problems has on its own.