Sequential Investment, Hold-Up, and Strategic Delay
Sequential Investment, Hold-up, and Strategic Delay
Juyan Zhang∗ and Yi Zhang† December 20, 2010
Abstract We investigate hold-up with simultaneous and sequential investment. We show that if the encouragement effect of sequential complementary investments dominates the delay effect, sequential investment alleviates the underinvestment caused by the hold-up problem. Further, if it is allowed to choose when to invest, strategic delay occurs when the encouragement effect of sequential complementary investments dominates the delay effect. JEL classification: C70, D23 Keywords: Sequential Investment, Hold-up, Underinvestment, Strategic Delay
∗ †
Southwestern University of Finance and Economics; zhangjuyan@gmail.com. Singapore Management University; yizhang@smu.edu.sg.
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Introduction
According to Che and S´kovics (2008), “hold-up arises when part of the return on an a agents relationship-specific investments is ex post expropriable by his trading partner.” With incomplete contract, which arises due to causes such as unforeseen contingencies and inability of enforcement, relationship-specific investments are distorted by the hold-up problem and are therefore insufficient. The current literature on hold-up (see the survey of Che and S´kovics 2008) mainly a focuses on the inefficiency issue due to the hold-up problem and organizational or contract remedies to achieve the first best through some ex post renegotiation design. In their models, relationship-specific investments are usually simultaneously invested. In contrast, we investigate hold-up with simultaneous and sequential investment and focus on the impact of sequential investment on inefficiency issue of underinvestment. We show that if the encouragement effect of sequential complementary investments dominates the delay effect, sequential investment alleviates the underinvestment caused by the hold-up problem. Further, if it is allowed to choose when to invest, strategic delay occurs when the encouragement
Juyan Zhang∗ and Yi Zhang† December 20, 2010
Abstract We investigate hold-up with simultaneous and sequential investment. We show that if the encouragement effect of sequential complementary investments dominates the delay effect, sequential investment alleviates the underinvestment caused by the hold-up problem. Further, if it is allowed to choose when to invest, strategic delay occurs when the encouragement effect of sequential complementary investments dominates the delay effect. JEL classification: C70, D23 Keywords: Sequential Investment, Hold-up, Underinvestment, Strategic Delay
∗ †
Southwestern University of Finance and Economics; zhangjuyan@gmail.com. Singapore Management University; yizhang@smu.edu.sg.
1
1
Introduction
According to Che and S´kovics (2008), “hold-up arises when part of the return on an a agents relationship-specific investments is ex post expropriable by his trading partner.” With incomplete contract, which arises due to causes such as unforeseen contingencies and inability of enforcement, relationship-specific investments are distorted by the hold-up problem and are therefore insufficient. The current literature on hold-up (see the survey of Che and S´kovics 2008) mainly a focuses on the inefficiency issue due to the hold-up problem and organizational or contract remedies to achieve the first best through some ex post renegotiation design. In their models, relationship-specific investments are usually simultaneously invested. In contrast, we investigate hold-up with simultaneous and sequential investment and focus on the impact of sequential investment on inefficiency issue of underinvestment. We show that if the encouragement effect of sequential complementary investments dominates the delay effect, sequential investment alleviates the underinvestment caused by the hold-up problem. Further, if it is allowed to choose when to invest, strategic delay occurs when the encouragement
References: [1] Che, Yeon-Koo, and J´zsef S´kovics. 2004. “A Dynamic Theory of Holdup.” Econoo a metrica, 72, 1063-1103. [2] Che, Yeon-Koo, and J´zsef S´kovics. 2008. “Hold-up Problem.” The New Palgrave o a Dictionary of Economics, 2nd edition. [3] Laffont, Jean-Jacques, and David Martimort. 2002. The Theory of Incentives: the Principal-Agent Model. Princeton University Press. [4] N¨ldeke, Georg, and Klaus M. Schmidt. 1998. “Sequential investments and options to o own.” Rand Journal Of Economics, 29(4): 633-53. [5] Smirnov, Vladimir, and Andrew Wait. 2004a. “Hold-Up and Sequential Specific Investments.” Rand Journal Of Economics, 35(2): 386-400. [6] Smirnov, Vladimir, and Andrew Wait. 2004b. “Timing of Investments, Holdup and Total Welfare.” International Journal of Industrial Organization, 22(3): 413-425. [7] Takayama, Akira. 1985. Mathematical Economics. 2d ed. Hinsdale, Ill.: Dryden. [8] Zhang, Juyan, and Yi Zhang. 2010. “Sequential Investment, Hold-up, and Ownership Structure.” Mimeo. 16