The Holdout Problem and Long-Term Contracting

Alexander Raskovich
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Alexander Raskovich: Economic Analysis Group, Antitrust Division, U.S. Department of Justice

No 200713, EAG Discussions Papers from Department of Justice, Antitrust Division

Abstract: The holdup problem of under-investment in specific capital has been studied extensively. Less attention has been paid to the "holdout" problem of over-investment in outside options. A buyer's gain from (unverifiably) developing an outside option exceeds the joint gain, given rent shifting when an inferior option binds in subsequent bargaining with the seller. Long-term contracts can solve holdout by increasing the buyer's surplus from trade within the relationship. With a nonbinding contract, however, the seller's participation constraint may require the buyer (who may be financially constrained) to pay a large signing bonus. This suggests a novel motive for vertical integration.

Pages: 33 pages
Date: 2007-09
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