Holdups, Standard Breach Remedies, and Optimal Investment

Aaron Edlin () and Stefan Reichelstein

No 5007, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We consider a bilateral trading problem in which one or both parties makes relationship-specific investments before trade. Without adequate contractual protection, the prospect of later holdups discourages investment. We postulate that the parties can sign noncontingent contracts prior to investing, and can freely renegotiate them after uncertainty about the desirability of trade is resolved. We find that such contracts can induce one party to invest efficiently when either a breach remedy of specific performance or expectation damages is applied. Specific performance can also induce both parties to invest efficiently, provided a separability condition holds. In contrast, expectation damages is poorly suited to solve bilateral investment problems.

JEL-codes: C7 D8 K12 L22 (search for similar items in EconPapers)
Date: 1995-02
Note: LE
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Citations: View citations in EconPapers (4)

Published as American Economic Review, vol. 86, no. 3, pp. 478-501, June 1996.

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Journal Article: Holdups, Standard Breach Remedies, and Optimal Investment (1996)
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