Formal Contracts, Relational Contracts, and the Holdup Problem

Hideshi Itoh and Hodaka Morita ()

No 1786, CESifo Working Paper Series from CESifo

Abstract: We study the holdup problem in repeated transactions between a seller and a buyer such that the seller makes relation-specific investments in each period. We show that where, under spot transaction, formal contracts have no value because of the cooperative nature of investment, writing a simple fixed-price contract can be valuable under repeated transactions: There is a range of parameter values in which a higher investment can be implemented only if a formal price contract is written and combined with a relational contract. We also show that there are cases in which not writing a formal contract but entirely relying on a relational contract increases the total surplus of the buyer and the seller. The key condition is how the investment affects the renegotiation price in general, and the alternative-use value in particular.

Keywords: holdup problem; formal contract; relational contract; cooperative investment; fixed-price contract; relation-specific investment; renegotiation; repeated transactions; long-term relationships (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-bec and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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