DP1645 Sequential Investments and Options to Own
This paper analyses the investment incentives given by contingent ownership structures that are prevalent in joint ventures. We consider a variation of the standard hold-up problem where two parties make relationship-specific investments sequentially in order to generate a joint surplus in the future. In many interesting cases, including investments in human and in physical capital, the following ownership structure implements first-best investments: one party owns the firm initially, while the other party has the option to buy the firm at a set price at a later date. This result is robust to the possibility of renegotiation and uncertainty.