DP7584 Contractual solutions to hold-up problems with quality uncertainty and unobservable investments
|Author(s):||Patrick W. Schmitz|
|Publication Date:||December 2009|
|Keyword(s):||common values, hidden action, hidden information, hold-up problem|
|JEL(s):||D23, D82, D86|
|Programme Areas:||Industrial Organization|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=7584|
Consider a seller and a buyer who write a contract. After that, the seller produces a good. She can influence the expected quality of the good by making unobservable investments. Only the seller learns the realized quality. Finally, trade can occur. It is always ex post efficient to trade. Yet, it may be impossible to achieve the first best, even though the risk-neutral parties are symmetrically informed at the contracting stage and complete contracts can be written. The second best is characterized by distortions that are reminiscent of adverse selection models (i.e., models with precontractual private information but without hidden actions).