Elsevier

Journal of Economic Theory

Volume 150, March 2014, Pages 683-708
Journal of Economic Theory

Investments as signals of outside options

https://doi.org/10.1016/j.jet.2013.12.001Get rights and content
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Abstract

Consider a seller who can make an observable but non-contractible investment to improve an intermediate good that is specialized to a particular buyerʼs needs. The buyer then makes a take-it-or-leave-it offer to the seller. The seller has private information about the fraction of the ex post surplus that he can realize on his own. Compared to a situation with complete information, additional investment incentives are generated by the sellerʼs desire to pretend a strong outside option. On the other hand, ex post efficiency is not attained since asymmetric information at the bargaining stage sometimes leads to inefficient separations.

JEL classification

D23
D82
D86

Keywords

Incomplete contracts
Relationship-specific investments
Hold-up problem
Signaling games

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