DP9050 The hold-up problem, innovations, and limited liability

Author(s):	Patrick W. Schmitz
Publication Date:	July 2012
Keyword(s):	hold-up problem, incomplete contracts, limited liability, research and development
JEL(s):	D86, L23, O31
Programme Areas:	Industrial Organization
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=9050

An inventor can invest research effort to come up with an innovation. Once an innovation is made, a contract is negotiated and unobservable effort must be exerted to develop a product. In the absence of liability constraints, the inventor's investment incentives are increasing in his bargaining power. Yet, given limited liability, overinvestments may occur and the inventor's investment incentives may be decreasing in his bargaining power.