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Information and the hold‐up problem
Author(s) -
Hermalin Benjamin E.,
Katz Michael L.
Publication year - 2009
Publication title -
the rand journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.687
H-Index - 108
eISSN - 1756-2171
pISSN - 0741-6261
DOI - 10.1111/j.1756-2171.2009.00071.x
Subject(s) - investment (military) , sunk costs , microeconomics , economics , principal (computer security) , welfare , business , market economy , politics , political science , computer science , law , operating system
We examine situations in which a party must make a sunk investment prior to contracting with a second party to purchase an essential complementary input. We study how the resulting hold‐up problem is affected by the seller's information about the investing party's likely returns from its investment. Our principal focus is on the effects of the investment's being observable by the noninvesting party. We establish conditions under which the seller's ability to observe the buyer's investment harms the seller, benefits the buyer, and reduces equilibrium investment and total surplus. We also note conditions under which investment and welfare rise when investment is observable.