IDEAS home Printed from https://ideas.repec.org/p/upf/upfgen/799.html
   My bibliography  Save this paper

Specificity revisited: The role of cross-investments

Author

Listed:
  • Matthew Ellman

Abstract

Previous analysis has shown that traders may opt for specific technologies with no joint productivity advantage as a way to commit themselves to trading jointly, but only when long-term contracting is infeasible. This paper proves that speciÞcity can also be optimal (by relaxing the budget-balance constraint) in settings with long-term contracting. Traders will opt for specificity when one trader makes a cross-investment and either (1) this cross-investment has a direct externality on the other trader, (2) both parties invest, or (3) private information is present. The specificity (e.g. from non- salvageable investments, specific assets and technologies, narrow business strategies, and exclusivity restrictions) is equally effective regardless of which trader's alternative trade payoff is reduced. Specificity supports long-term contracts in a broad range of settings - both with and without renegotiation. The theory also offers a novel perspective on franchising and vertical integration.

Suggested Citation

  • Matthew Ellman, 2004. "Specificity revisited: The role of cross-investments," Economics Working Papers 799, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2005.
    • Handle: RePEc:upf:upfgen:799
    as

    Download full text from publisher

    File URL: https://econ-papers.upf.edu/papers/799.pdf
    File Function: Whole Paper
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-785, July.
    2. Rotemberg, Julio J & Saloner, Garth, 1994. "Benefits of Narrow Business Strategies," American Economic Review, American Economic Association, vol. 84(5), pages 1330-1349, December.
    3. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 2002. "On partial contracting," European Economic Review, Elsevier, vol. 46(4-5), pages 745-753, May.
    4. Yeon-Koo Che & Jozsef Sakovics, 2004. "Contractual Remedies to the Holdup Problem: A Dynamic Perspective," Edinburgh School of Economics Discussion Paper Series 100, Edinburgh School of Economics, University of Edinburgh.
    5. Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 39-56.
    6. Francine Lafontaine & Joanne E. Oxley, 2004. "International Franchising Practices in Mexico: Do Franchisors Customize Their Contracts?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(1), pages 95-123, March.
    7. Georg Noeldeke & Klaus Schmidt, 1998. "Sequential Investments and Options to Own," RAND Journal of Economics, The RAND Corporation, vol. 29(4), pages 633-653, Winter.
    8. Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter.
    9. Martin J. Osborne & Ariel Rubinstein, 2005. "Bargaining and Markets," Levine's Bibliography 666156000000000515, UCLA Department of Economics.
    10. Thomas P. Lyon, 2004. "Buyer-Option Contracts Restored: Renegotiation, Inefficient Threats, and the Hold-Up Problem," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 20(1), pages 148-169, April.
    11. Mukesh Eswaran & Ashok Kotwal, 1984. "The Moral Hazard of Budget-Breaking," RAND Journal of Economics, The RAND Corporation, vol. 15(4), pages 578-581, Winter.
    12. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    13. Werner, Raub & Keren, Gideon, 1993. "Hostages as a commitment device : A game-theoretic model and an empirical test of some scenarios," Journal of Economic Behavior & Organization, Elsevier, vol. 21(1), pages 43-67, May.
    14. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, vol. 83(4), pages 811-837, September.
    15. Arya Anil & Frimor Hans & Mittendorf Brian, 2003. "Pouring Money Down the Drain? How Sunk Investments and Signing Bonuses can Improve Employee Incentives," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 3(1), pages 1-14, June.
    16. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-641, August.
    17. Edlin, Aaron S & Hermalin, Benjamin E, 2000. "Contract Renegotiation and Options in Agency Problems," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 16(2), pages 395-423, October.
    18. Joel S. Demski & David E.M. Sappington, 1991. "Resolving Double Moral Hazard Problems with Buyout Agreements," RAND Journal of Economics, The RAND Corporation, vol. 22(2), pages 232-240, Summer.
    19. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
    20. George Baker & Robert Gibbons & Kevin J. Murphy, 2002. "Relational Contracts and the Theory of the Firm," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(1), pages 39-84.
    21. David de Meza & Mariano Selvaggi, 2004. "Exclusive Contracts Foster Relationship-Specific Investment," The Centre for Market and Public Organisation 04/105, The Centre for Market and Public Organisation, University of Bristol, UK.
    22. Francine Lafontaine, 1992. "Agency Theory and Franchising: Some Empirical Results," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 263-283, Summer.
    23. repec:rus:hseeco:71610 is not listed on IDEAS
    24. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
    25. David de Meza & Marianno Selvaggi, 2003. "Please Hold me Up: Why Firms Grant Exclusive Dealing Contracts," The Centre for Market and Public Organisation 03/066, The Centre for Market and Public Organisation, University of Bristol, UK.
    26. Julio Rotemberg & Garth Saloner, 2000. "Visionaries, Managers, and Strategic Direction," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 693-716, Winter.
    27. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
    28. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-460, March.
    29. Rubin, Paul H, 1978. "The Theory of the Firm and the Structure of the Franchise Contract," Journal of Law and Economics, University of Chicago Press, vol. 21(1), pages 223-233, April.
    30. Kahn, Charles & Huberman, Gur, 1988. "Two-sided Uncertainty and "Up-or-Out" Contracts," Journal of Labor Economics, University of Chicago Press, vol. 6(4), pages 423-444, October.
    31. Alan Schwartz, 2004. "The Law and Economics of Costly Contracting," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 20(1), pages 2-31, April.
    32. Ilya Segal & Michael D. Whinston, 2000. "Exclusive Contracts and Protection of Investments," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 603-633, Winter.
    33. Schwartz, Alan & Watson, Joel, 2001. "The Law and Economics of Costly Contracting," University of California at San Diego, Economics Working Paper Series qt2wh8m7bv, Department of Economics, UC San Diego.
    34. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
    35. Jolls, Christine, 1997. "Contracts as Bilateral Commitments: A New Perspective on Contract Modification," The Journal of Legal Studies, University of Chicago Press, vol. 26(1), pages 203-237, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Christian Balcells, 2022. "Determinants of firm boundaries and organizational performance: an empirical investigation of the Chilean truck market," Journal of Evolutionary Economics, Springer, vol. 32(2), pages 423-461, April.
    2. Christoph Lülfesmann, 2021. "Strategic Shirking in Bilateral Trade," Scandinavian Journal of Economics, Wiley Blackwell, vol. 123(4), pages 1292-1313, October.
    3. Göller, Daniel, 2015. "Contract, Renegotiation, and Holdup: When Should Messages be Sent?," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113166, Verein für Socialpolitik / German Economic Association.
    4. Matthew Ellman, 2006. "The optimal length of contracts with application to outsourcing," Economics Working Papers 965, Department of Economics and Business, Universitat Pompeu Fabra.
    5. Maija Halonen‐Akatwijuka, 2010. "Organizational Design, Technology and the Boundaries of the Firm," Economica, London School of Economics and Political Science, vol. 77(307), pages 544-564, July.
    6. Christian A. Ruzzier, 2009. "Asset Specificity and Vertical Integration: Williamson’s Hypothesis Reconsidered," Harvard Business School Working Papers 09-119, Harvard Business School.
    7. David Meza & Mariano Selvaggi, 2007. "Exclusive contracts foster relationship-specific investment," RAND Journal of Economics, RAND Corporation, vol. 38(1), pages 85-97, March.
    8. Buzard, Kristy & ,, 2012. "Contract, renegotiation, and hold up: Results on the technology of trade and investment," Theoretical Economics, Econometric Society, vol. 7(2), May.
    9. Ola Kvaløy & Ragnar Tveterås, 2008. "Cost Structure and Vertical Integration between Farming and Processing," Journal of Agricultural Economics, Wiley Blackwell, vol. 59(2), pages 296-311, June.
    10. 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.
    11. Agamirova, Maria Е. (Агамирова, Мария) & Dzagurova, Nataliya B. (Дзагурова, Наталия), 2016. "The Legality of Vertical Restraints by the Rule of Reason and the Character of the Specific Investments [Правомерность Вертикальных Ограничивающих Соглашений С Позиции "Взвешенного Подхода&quo," Ekonomicheskaya Politika / Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 6, pages 122-137, December.
    12. 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.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    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. Ilya Segal & Michael D.Whinston, 2012. "Property Rights [The Handbook of Organizational Economics]," Introductory Chapters,, Princeton University Press.
    3. Robert Gibbons & John Roberts, 2012. "The Handbook of Organizational Economics," Economics Books, Princeton University Press, edition 1, volume 1, number 9889.
    4. 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.
    5. 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.
    6. Yeon-Koo Che & Jozsef Sakovics, 2006. "The Hold-up Problem," Edinburgh School of Economics Discussion Paper Series 142, Edinburgh School of Economics, University of Edinburgh.
    7. Watson, Joel, 2002. "Contract, Mechanism Design, and Technological Detail," University of California at San Diego, Economics Working Paper Series qt18x0r2nn, Department of Economics, UC San Diego.
    8. Joel Watson, 2013. "Contract and Game Theory: Basic Concepts for Settings with Finite Horizons," Games, MDPI, vol. 4(3), pages 1-40, August.
    9. Joel Watson, 2007. "Contract, Mechanism Design, and Technological Detail," Econometrica, Econometric Society, vol. 75(1), pages 55-81, January.
    10. Surajeet Chakravarty & W. Bentley MacLeod, 2004. "On the Efficiency of Standard Contracts the Case of Construction," Working Papers 874, Princeton University, Department of Economics, Industrial Relations Section..
    11. Surajeet Chakravarty & Bentley MacLeod, 2004. "On the Efficiency of Standard Contracts the Case of Construction," Working Papers 874, Princeton University, Department of Economics, Industrial Relations Section..
    12. Matthew Ellman, 2006. "The optimal length of contracts with application to outsourcing," Economics Working Papers 965, Department of Economics and Business, Universitat Pompeu Fabra.
    13. Alan Schwartz, 2004. "The Law and Economics of Costly Contracting," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 20(1), pages 2-31, April.
    14. Guriev Sergei, 2003. "Incomplete Contracts with Cross-Investments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 3(1), pages 1-32, August.
    15. Patrick W. Schmitz, 2005. "Should Contractual Clauses that Forbid Renegotiation Always be Enforced?," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 21(2), pages 315-329, October.
    16. repec:eee:labchp:v:3:y:1999:i:pb:p:2291-2372 is not listed on IDEAS
    17. Schwartz, Alan & Watson, Joel, 2000. "Economic and Legal Aspects of Costly Recontracting," University of California at San Diego, Economics Working Paper Series qt4jr3g3h7, Department of Economics, UC San Diego.
    18. Schwartz, Alan & Watson, Joel, 2001. "The Law and Economics of Costly Contracting," University of California at San Diego, Economics Working Paper Series qt2wh8m7bv, Department of Economics, UC San Diego.
    19. Francine Lafontaine & Margaret Slade, 2007. "Vertical Integration and Firm Boundaries: The Evidence," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 629-685, September.
    20. Andreas Roider, 2004. "Asset Ownership and Contractibility of Interaction," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 787-802, Winter.
    21. Hideshi Itoh & Hodaka Morita, 2015. "Formal Contracts, Relational Contracts, and the Threat-Point Effect," American Economic Journal: Microeconomics, American Economic Association, vol. 7(3), pages 318-346, August.

    More about this item

    Keywords

    Specificity; hostages long-term contracting; cross-investments; budget-balance; renegotiation;
    All these keywords.

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:upf:upfgen:799. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: http://www.econ.upf.edu/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.