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Optimal Contract Design with Unilateral Market Option

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  • Antonio Nicita
  • Simone Sepe

Abstract

Contrary to previous literature, we show that the assignment of authority decision matters in optimal contract design with bilateral specific self-investments. This is the case when we enlarge the set of the states of nature, to explicitly consider the event that a party's market option turns out to be binding ex-post. We show that, under this setting, simple contracts protected by specific performance remedies may generate hold-up and thus parties' incentives to under-invest. However, investment efficiency is enhanced when authority is assigned to the party with ex-post binding market option. Our results suggest a neglected rationale for vertical integration as a remedy against hold-up

Suggested Citation

  • Antonio Nicita & Simone Sepe, 2010. "Optimal Contract Design with Unilateral Market Option," Department of Economics University of Siena 593, Department of Economics, University of Siena.
    • Handle: RePEc:usi:wpaper:593
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    File URL: http://repec.deps.unisi.it/quaderni/593.pdf
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    References listed on IDEAS

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    1. Chatterjee Kalyan & Chiu Y. Stephen, 2007. "When Does Competition Lead to Efficient Investments?," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 7(1), pages 1-39, July.
    2. Klein, Benjamin, 1996. "Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships," Economic Inquiry, Western Economic Association International, vol. 34(3), pages 444-463, July.
    3. De Meza, D. & Lockwood, Ben, 1997. "Does Asset Ownership Always Motivate Managers? The Property Rights Theory of the Firm with Alternating - Offers Bargaining," Discussion Papers 9701, University of Exeter, Department of Economics.
    4. Casadesus-Masanell, Ramon & Spulber, Daniel F, 2000. "The Fable of Fisher Body," Journal of Law and Economics, University of Chicago Press, vol. 43(1), pages 67-104, April.
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    More about this item

    Keywords

    incomplete contracts; outside options; mechanism design;
    All these keywords.

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General

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