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Incomplete Contracts with Cross-Investments

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  • Guriev Sergei

    (New Economic School, Moscow)

Abstract

We study an incomplete contract model where both contracting parties can invest, and the investments have both self- and cross-effects. We analyze the performance of non-contingent contracts, message games, option contracts and property rights. We find that the first best is implemented if (i) the cross effects are negative or weaker than self-effects; (ii) the strength of cross-effects relative to self-effects is symmetric across parties. If either of these conditions is violated, even message contingent revelation mechanisms fail to provide efficient incentives. For this case, we obtain a number of results characterizing the second best. We find that property rights outperform contracts and partially relax the symmetry constraint. In either first best or second best, the stronger the cross-effects, the lower the value of contracting. The optimal allocation of property rights assigns ownership to the party with stronger cross-effects.

Suggested Citation

  • Guriev Sergei, 2003. "Incomplete Contracts with Cross-Investments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 3(1), pages 1-32, August.
    • Handle: RePEc:bpj:bejtec:v:contributions.3:y:2003:i:1:n:5
    DOI: 10.2202/1534-5971.1048
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    Cited by:

    1. Buzard, Kristy & ,, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
    2. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
    3. Richard R.W. Brooks & Alexander Stremitzer, 2012. "On and Off Contract Remedies Inducing Cooperative Investments," American Law and Economics Review, American Law and Economics Association, vol. 14(2), pages 488-516.
    4. Sergei Guriev & Dmitriy Kvasov, 2005. "Contracting on Time," American Economic Review, American Economic Association, vol. 95(5), pages 1369-1385, December.
    5. Andreas Roider, 2004. "Asset Ownership and Contractibility of Interaction," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 787-802, Winter.
    6. Schmitz, Patrick W., 2010. "Contractual solutions to hold-up problems with quality uncertainty and unobservable investments," Journal of Mathematical Economics, Elsevier, vol. 46(5), pages 807-816, September.
    7. Watson, Joel & Buzard, Kristy, 2009. "Contract, Renegotiation, and Hold Up: General Results on the Technology of Trade and Investment," University of California at San Diego, Economics Working Paper Series qt3923q7kz, Department of Economics, UC San Diego.
    8. Watson, Joel & Wignall, Chris, 2009. "Hold-Up and Durable Trading Opportunities," University of California at San Diego, Economics Working Paper Series qt8p8284wg, Department of Economics, UC San Diego.
    9. Alexander Stremitzer, 2012. "Standard Breach Remedies, Quality Thresholds, and Cooperative Investments," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 28(2), pages 337-359.
    10. Robert Gibbons & John Roberts, 2012. "The Handbook of Organizational Economics," Economics Books, Princeton University Press, edition 1, volume 1, number 9889.
    11. Valeria Gattai & Piergiovanna Natale, 2014. "Joint Ventures and the Property Rights Theory of the Firm: a Review of the Literature," Working Papers 287, University of Milano-Bicocca, Department of Economics, revised Dec 2014.
    12. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, September.
    13. Valeria Gattai & Piergiovanna Natale, 2016. "Optimal Ownership Regime in the Presence of Investment Spillovers," Working Papers 332, University of Milano-Bicocca, Department of Economics, revised 29 Mar 2016.
    14. Patrick W. Schmitz, 2006. "Information Gathering, Transaction Costs, and the Property Rights Approach," American Economic Review, American Economic Association, vol. 96(1), pages 422-434, March.
    15. Brooks, Richard & Stremitzer, Alexander, 2009. "On and Off Contract Remedies," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 290, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    16. Gattai, Valeria & Natale, Piergiovanna, 2016. "Investment spillovers and the allocation of property rights," Economics Letters, Elsevier, vol. 145(C), pages 109-113.
    17. Valeria Gattai & Piergiovanna Natale, 2017. "A New Cinderella Story: Joint Ventures And The Property Rights Theory Of The Firm," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 281-302, February.
    18. Göller, Daniel & Stremitzer, Alexander, 2009. "Breach Remedies Including Hybrid Investments," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 282, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    19. Ilya Segal & Michael D.Whinston, 2012. "Property Rights [The Handbook of Organizational Economics]," Introductory Chapters,, Princeton University Press.

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