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Caveat Venditor: The Conditional Effect of Relationship-Specific Investment on Contractual Behavior

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  • Peter Murrell
  • Radu A. Păun

Abstract

We examine the effect of relationship-specific investment on the use of detailed contracts using data on transactions from a survey of Romanian firms. In those transactions, seller relationship-specific investment increases the amount of contractual detail, while buyer relationship-specific investment decreases it. We interpret these results using a hostages model applied to cash-flow and credit constrained firms. Sellers are more likely to be vulnerable to hold up than buyers are, implying that seller losses from hold up (and consequently the incentive to use a more detailed contract) increase with seller investment and decrease with buyer investment. This leads to the asymmetric effects of buyer and seller relationship-specific investment. Asymmetry is present in empirical estimates using a variety of methods that counter bias due to the endogeneity of the specific-investment variables, but is not present in OLS estimates. The hostages model with cash-constrained firms predicts the differences between OLS and consistent estimates. (JEL D23, K12, L14, P3)

Suggested Citation

  • Peter Murrell & Radu A. Păun, 2017. "Caveat Venditor: The Conditional Effect of Relationship-Specific Investment on Contractual Behavior," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 33(1), pages 105-138.
    • Handle: RePEc:oup:jleorg:v:33:y:2017:i:1:p:105-138.
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    File URL: http://hdl.handle.net/10.1093/jleo/eww011
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    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • P3 - Political Economy and Comparative Economic Systems - - Socialist Institutions and Their Transitions

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