Discussion paper

DP8366 Investments as Signals of Outside Options

Consider a seller who can make an observable but non-contractible investment to improve an intermediate good that is specialized to a particular buyer's 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 seller's desire to pretend a strong outside option. On the other hand, ex post efficiency is not attained whenever the buyer mistakenly tries to call the seller's bluff with a low offer.

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Citation

Schmitz, P and S Goldlücke (2011), ‘DP8366 Investments as Signals of Outside Options‘, CEPR Discussion Paper No. 8366. CEPR Press, Paris & London. https://cepr.org/publications/dp8366