Hold-up and the evolution of investment and bargaining norms

The purpose of this paper is to explore the evolution of bargaining norms in a simple team production problem with two sided relationship specific investments and competition. The puzzle we wish to address is why efficient bargaining norms do not evolve even though there exist efficient sequential equilibria? Conditions under which stochastically stable bargaining conventions exist are characterized, and it is shown that the stochastically stable division rule is independent of the long run investment strategy. Hence, efficient sequential equilibria are not in general stochastically stable, a result that may help us understand why institutions, such as firms, may be needed to ensure efficient exchange in the context of relationship specific investments. We also find that increasing competition, while enhancing incentives, may also destabilize existing bargaining norms, and may explain why the introduction of market in transition economics may initially result in reduced output. JEL Classification: C78, D83, Z13