DP7205 Can Contracts Solve the Hold-Up Problem? Experimental Evidence

Author(s): Eva I Hoppe, Patrick W. Schmitz
Publication Date: March 2009
Keyword(s): Experiment, Hold-up problem, Option contracts, Renegotiation
JEL(s): C72, C91, D86
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=7205

In the contract-theoretic literature, there is a vital debate about whether contracts can mitigate the hold-up problem when renegotiation cannot be prevented. Ultimately, the question has to be answered empirically. As a first step in that direction, we have conducted a laboratory experiment with 490 participants. We consider "cooperative" investments that directly benefit the non-investing party. While according to standard theory, contracting would be useless if renegotiation cannot be ruled out, we find that option contracts significantly improve investment incentives compared to a no-contract treatment. This finding can be explained by Hart and Moore’s (2008) notion that contracts may serve as reference points.