Contract Design When Relationship-Specific Investment Produces Asymmetric Information

Albert H. Choi and George Triantis

The Journal of Legal Studies, 2021, vol. 50, issue 2, 219 - 260

Abstract: Under conventional contract theory, contracts may be efficient by protecting relationship-specific investment from holdup in subsequent (re)negotiation over terms of trade. This paper demonstrates a different problem when specific investment also provides significant private information to the investing party. This is fairly common: for example, a manufacturer invests to learn about its buyer’s idiosyncratic needs or a collaborator invests to learn about a joint venture. We show how such private information can lead to subsequent bargaining failure and suboptimal ex ante relationship-specific investment. We also show that this inefficiency is worse if the parties enter into a binding and renegotiable contract to trade before the investment is made. This may explain why some preliminary agreements are expressly nonbinding. Finally, we demonstrate that parties may reduce inefficiency by agreeing to negotiate in good faith or other such knowledge-based provisions, especially when these promises are backed by expectation rather than reliance damages.

Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
http://dx.doi.org/10.1086/716173 (application/pdf)
http://dx.doi.org/10.1086/716173 (text/html)
Access to the online full text or PDF requires a subscription.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ucp:jlstud:doi:10.1086/716173

Access Statistics for this article

More articles in The Journal of Legal Studies from University of Chicago Press
Bibliographic data for series maintained by Journals Division ().