Sunk Costs and the Inefficiency of Relationship‐Specific Investment

Abhinay Muthoo

Economica, 1998, vol. 65, issue 257, 97-106

Abstract: It is well known that relationship‐specific investment will be inefficient when the parties are unable to write (binding) long‐term contracts. In this note I exploit some of the recent developments in strategic bargaining theory in order to explore the relationship between the degree of inefficiency in the level of such relationship‐specific investment and the degree of sunkness in the cost of investment. One result obtained is that the underinvestment result is not sensitive to the degree of sunkness in the cost of investment. Another result is that each player may actually overinvest when the cost of investment is not sunk.

Date: 1998
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