Rigidity in bilateral trade with holdup

, R. ()
Additional contact information
, R.: Department of Economics, University at Albany, SUNY
Authors registered in the RePEc Author Service: Rui Zhao

Theoretical Economics, 2008, vol. 3, issue 1

Abstract: This paper studies bilateral trade in which the seller makes a hidden investment that influences the buyer's hidden valuation. In general it is impossible to implement both first-best efficient trade and efficient investment using budget-balanced trading mechanisms. The paper fully characterizes the constrained efficient contracts. It is shown that the optimal tradeoff between allocative efficiency and incentive provision results in rigidity in trade, the degree of which depends on the seriousness of the holdup problem. Sufficient conditions are also provided for full separation of buyer types to take place in optimal contracts when the holdup problem is not too severe. The seller may overinvest relative to the first best.

Keywords: Bilateral contracting; hidden action and hidden information; holdup problem; nonlinear pricing (search for similar items in EconPapers)
JEL-codes: C72 D20 D82 (search for similar items in EconPapers)
Date: 2008-03-04
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Citations: View citations in EconPapers (8)

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