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Equity Stakes and Hold-up Problems

23 Pages Posted: 14 Mar 2002  

Rick Harbaugh

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy; Indiana University - Department of Economics

Date Written: September 2001

Abstract

Equity ties between businesses change the division of the firms' joint profits, thereby affecting incentives for relation-specific investments and other strategic actions. Depending on which side owns the equity and how readily the equity can be resold, we find that the changed incentives can resolve all four types of holdup-related problems: underinvestment, overinvestment, undercooperation, and sabotage. Equity stakes indirectly affect bargaining over the joint profits by making the bargaining positions of the firms dependent on each other. For instance, if one firm is made unprofitable by a breakdown in negotiations, the other firm loses as well. Since bargaining positions are linked, each firm benefits less from attempts to grab a larger share of the joint profits by strengthening its relative bargaining position, and benefits more from actions that increase joint profits. While both firms can gain from increased efficiency due to the equity stake, firms in many cases should only acquire an equity stake if they can bargain for a discounted price.

Keywords: equity blocks, subsidiaries, gainsharing, partial ownership, business groups, ESOPs

JEL Classification: L14, L22, G31, G32, G34, C78

Suggested Citation

Harbaugh, Rick, Equity Stakes and Hold-up Problems (September 2001). Claremont Colleges Working Paper 2001-31. Available at SSRN: https://ssrn.com/abstract=303208 or http://dx.doi.org/10.2139/ssrn.303208

Rick Harbaugh (Contact Author)

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy ( email )

Bloomington, IN 47405
United States
812-855-2777 (Phone)
812-855-3354 (Fax)

HOME PAGE: http://www.bus.indiana.edu/riharbau/

Indiana University - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

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