Contractual Solutions to Hold-Up Problems with Quality Uncertainty and Unobservable Investments

24 Pages Posted: 11 Jan 2010

See all articles by Patrick W. Schmitz

Patrick W. Schmitz

University of Cologne; Centre for Economic Policy Research (CEPR)

Date Written: December 2009

Abstract

Consider a seller and a buyer who write a contract. After that, the seller produces a good. She can influence the expected quality of the good by making unobservable investments. Only the seller learns the realized quality. Finally, trade can occur. It is always ex post efficient to trade. Yet, it may be impossible to achieve the first best, even though the risk-neutral parties are symmetrically informed at the contracting stage and complete contracts can be written. The second best is characterized by distortions that are reminiscent of adverse selection models (i.e., models with precontractual private information but without hidden actions).

Keywords: common values, hidden action, hidden information, hold-up problem

JEL Classification: D23, D82, D86

Suggested Citation

Schmitz, Patrick W., Contractual Solutions to Hold-Up Problems with Quality Uncertainty and Unobservable Investments (December 2009). CEPR Discussion Paper No. DP7584. Available at SSRN: https://ssrn.com/abstract=1533189

Patrick W. Schmitz (Contact Author)

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

HOME PAGE: http://schmitz.uni-koeln.de/index.php?s=mitarbeiter&t=schmitz

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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