Optimal Contract Design with Unilateral Market Option

Antonio Nicita () and Simone Sepe ()

Department of Economics University of Siena from Department of Economics, University of Siena

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

Keywords: incomplete contracts; outside options; mechanism design (search for similar items in EconPapers)
JEL-codes: C70 J41 K12 L22 (search for similar items in EconPapers)
Date: 2010-05
New Economics Papers: this item is included in nep-bec, nep-cta and nep-law
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Persistent link: https://EconPapers.repec.org/RePEc:usi:wpaper:593

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