Holdups, Standard Breach Remedies, and Optimal Investment

43 Pages Posted: 6 Sep 2000 Last revised: 17 Sep 2010

See all articles by Aaron S. Edlin

Aaron S. Edlin

University of California at Berkeley; National Bureau of Economic Research (NBER)

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business; CESifo (Center for Economic Studies and Ifo Institute)

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Date Written: February 1995

Abstract

We consider a bilateral trading problem in which one or both parties makes relationship-specific investments before trade. Without adequate contractual protection, the prospect of later holdups discourages investment. We postulate that the parties can sign noncontingent contracts prior to investing, and can freely renegotiate them after uncertainty about the desirability of trade is resolved. We find that such contracts can induce one party to invest efficiently when either a breach remedy of specific performance or expectation damages is applied. Specific performance can also induce both parties to invest efficiently, provided a separability condition holds. In contrast, expectation damages is poorly suited to solve bilateral investment problems.

Suggested Citation

Edlin, Aaron S. and Reichelstein, Stefan J., Holdups, Standard Breach Remedies, and Optimal Investment (February 1995). NBER Working Paper No. w5007. Available at SSRN: https://ssrn.com/abstract=225786

Aaron S. Edlin (Contact Author)

University of California at Berkeley ( email )

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Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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