Investments as Signals of Outside Options
41 Pages Posted: 4 May 2011
Date Written: April 2011
Abstract
Consider a seller who can make an observable but non-contractible investment to improve an intermediate good that is specialized to a particular buyer's needs. The buyer then makes a take-it-or-leave-it offer to the seller. The seller has private information about the fraction of the ex post surplus that he can realize on his own. Compared to a situation with complete information, additional investment incentives are generated by the seller's desire to pretend a strong outside option. On the other hand, ex post efficiency is not attained whenever the buyer mistakenly tries to call the seller's bluff with a low offer.
Keywords: hold-up problem, incomplete contracts, relationship-specific investments, signaling games
JEL Classification: D23, D82, D86
Suggested Citation: Suggested Citation
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Investments as Signals of Outside Options
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