Barriers to Network-Specific Investment
Federal Reserve Bank of New York - Research and Statistics
Michael J. Orlando
Economic Advisors, Inc.; University of Colorado at Denver; Tulane University
Review of Economic Dynamics, Forthcoming
We examine incentives for network-specific investment and consider the implications for network governance. We model a two-sided market in which participants making payments over a network platform can invest in a technology that reduces the marginal cost of using the platform. A network effect results in multiple equilibria - either all agents invest and use of the platform is high or no agents invest and use of the platform is low. The high-use equilibrium can be implemented if commitment is feasible. When the platform cannot commit to usage fees, investment in the platform-specific technology will be held-up, thus implementing the low-investment equilibrium. As a result, governance structures necessary to achieve commitment will be preferred to those necessary merely to achieve coordination. For example, mutual ownership by users of a network platform may emerge where users face risk of ex post renegotiation. Such a governance structure will also be sufficient to avoid low investment attributable to the network effect.
Number of Pages in PDF File: 38
Keywords: Network, Hold-up, Commitment, Two-sided market, Payments
JEL Classification: E59, G29, L14, L22Accepted Paper Series
Date posted: March 27, 2007
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