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Bargaining under Incomplete Information, Fairness, and the Hold-Up Problem

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  • Siemens, Ferdinand von

Abstract

In the hold-up problem incomplete contracts cause the proceeds of relation-specific investments to be allocated by ex-post bargaining. The present paper investigates the efficiency of incomplete contracts if individuals have heterogeneous preferences implying heterogeneous bargaining behavior and - equally important - preferences are private information. As the sunk investment costs can thus potentially signal preferences, they can influence beliefs and consequently bargaining outcomes. The necessities of signalling are shown to generate very strong investment incentives. These incentives are based on the desire not to reveal information that is unfavorable in the ensuing bargaining. After finding all perfect Bayesian equilibria in pure strategies, the paper derives the necessary and sufficient conditions under which it is optimal to invest and trade efficiently.

Suggested Citation

  • Siemens, Ferdinand von, 2005. "Bargaining under Incomplete Information, Fairness, and the Hold-Up Problem," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 57, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    • Handle: RePEc:trf:wpaper:57
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    File URL: https://epub.ub.uni-muenchen.de/13493/1/57.pdf
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    References listed on IDEAS

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    1. Lorne Carmichael & W. Bentley MacLeod, 2003. "Caring About Sunk Costs: A Behavioral Solution to Holdup Problems with Small Stakes," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 19(1), pages 106-118, April.
    2. Ernst Fehr & Klaus M. Schmidt, 1999. "A Theory of Fairness, Competition, and Cooperation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(3), pages 817-868.
    3. Troger, Thomas, 2002. "Why Sunk Costs Matter for Bargaining Outcomes: An Evolutionary Approach," Journal of Economic Theory, Elsevier, vol. 102(2), pages 375-402, February.
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    5. Ellingsen, Tore & Robles, Jack, 2002. "Does Evolution Solve the Hold-Up Problem?," Games and Economic Behavior, Elsevier, vol. 39(1), pages 28-53, April.
    6. Christian Ewerhart, 2006. "The Effect of Sunk Costs on the Outcome of Alternating-Offers Bargaining Between Inequity-Averse Agents," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 58(2), pages 184-203, April.
    7. Tore Ellingsen & Magnus Johannesson, 2004. "Is There a Hold‐up Problem?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(3), pages 475-494, October.
    8. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
    9. Rabin, Matthew, 1993. "Incorporating Fairness into Game Theory and Economics," American Economic Review, American Economic Association, vol. 83(5), pages 1281-1302, December.
    10. Gul, Faruk, 2001. "Unobservable Investment and the Hold-Up Problem," Econometrica, Econometric Society, vol. 69(2), pages 343-376, March.
    11. Gary E Bolton & Axel Ockenfels, 1997. "A Theory of Equity, Reciprocity, and Competition," Levine's Working Paper Archive 1889, David K. Levine.
    12. Crawford, Vincent P, 1982. "A Theory of Disagreement in Bargaining," Econometrica, Econometric Society, vol. 50(3), pages 607-637, May.
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    Cited by:

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    2. Sloof, Randolph, 2008. "Price-setting power vs. private information: An experimental evaluation of their impact on holdup," European Economic Review, Elsevier, vol. 52(3), pages 469-486, April.

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    More about this item

    Keywords

    Incomplete Contracts; Hold-Up; Fairness; Bargaining under Incomplete Information; Signalling;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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