Australian National University

An Asymptotic Solution to the Holdup Problem

Email address: rohan.pitchford@anu.edu.au

JEL Classifications: D23, C73, L14

Abstract:
We consider a setting in which th e hold-up problem is extremely severe: a seller's investment benefits a buyer; once the investment is sunk, the buyer cannot be excluded from enjoying the benefit; investment is observable to the parties but not contractible. We show that the parties can still come arbitrarily close to the complete-contracts first best by having the seller make a series of increasingly small investments, after each of which the buyer immediately reimburses the seller or the seller stops investing. The underlying problem differs markedly from the literature on reputation, relational contracting and staged investment. That literature studies problems in which a party's incentive to deviate is either stationary or falling over time. In our problem, the buyer's incentive to deviate from installment payments to the seller increases over time as the seller's aggregate investment increases.

PDF file of paper: Not available.

Session: Industrial Organization Theory II

Time: Saturday, 7 July, 2:15pm - 3:45pm

Room: D