DP9396 Investments in physical capital, relationship-specificity, and the property rights approach

Author(s): Patrick W. Schmitz
Publication Date: March 2013
Keyword(s): incomplete contracts, investment incentives, ownership, relationship-specificity, theory of the firm
JEL(s): C78, D23, D86, L22, L24
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9396

We reconsider the property rights approach to the theory of the firm based on incomplete contracts. We explore the implications of different degrees of relationship-specificity when there are two parties, A and B, who can make investments in physical capital (instead of human capital). If relationship-specificity is exogenously given, it turns out that joint asset ownership can be optimal only if the degree of relationship-specificity is sufficiently small. If relationship-specificity can be freely chosen and if party A's investments are more productive, then the parties deliberately choose a strictly positive level of relationship-specificity and they always agree on sole ownership by party A.