The Hold-Up Problem in a Repeated Relationship

Abstract:     
Much of the literature on what determines the scope of operations of a producer has centered on the ``hold-up problem". The standard results indicate the hold-up problem may lead to suboptimal investments, and therefore integration may improve the organization of production. In this paper, we consider a repeated relationship with durable investments and show the possibility of integration improves the choice of investments and there is no integration in equilibrium. The equilibrium contract is non-exclusive, in order to allow the buyer to choose integration in later periods. We derive this result in the presence of very simple and incomplete contracts.

Keywords: incomplete contracts, outside options, vertical integration

JEL Classification: D23, L22

Accepted Paper Series