Contracting still matters! Or: How to design a letter of intent

Evelyn Korn and Stephan Meisenzahl ()
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Stephan Meisenzahl: Philipps-University Marburg

No 200909, MAGKS Papers on Economics from Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung)

Abstract: Any cooperation that profits from relation-specific investments suffers from the well-known hold-up problem. If investments are not enforceable by an outside authority, the gains fall prey to individual opportunism caused by a free-rider problem. If, in addition, individual investments exhibit positive cross effects, Che and Hausch (1999) provide a negative result and show that contracts cannot overcome the hold up due to a lack of verifiable commitment. This paper develops a mechanism that provides such a commitment device: (1) It introduces an acknowledgement game that procures reliable. (2) It embeds the original contracting problem into two institutional designs - a market based one and a private design - that support enforcement. These two devices reestablish efficient investments as enforceable results of a contract.

Pages: 40 pages
Date: 2009
New Economics Papers: this item is included in nep-cta
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https://www.uni-marburg.de/en/fb02/research-groups ... ers/09-2009_korn.pdf First version, 2009 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:mar:magkse:200909

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