Does Contract Enforcement Mitigate Hold Up?

Abstract

This paper provides novel evidence that stronger contract enforcement mitigates hold up in business investment decisions using stark, externally imposed variation in contract enforcement across Native American reservations. My tests focus on the golf course industry, which involves a high degree of sunk costs and long investment horizons, and is thus, naturally subject to the classical hold up problem. I find that state courts, which provide stronger contract enforcement than tribal courts, lead to at least 27% more golf courses, with greater effects in areas with greater natural amenities. These findings suggest that courts play an important role in facilitating the oft-discussed contractual solutions to the hold up problem.

Keywords: Hold-Up, Contract Enforcement, Investment, Native American Reservations

JEL Classification: G31, K40, P48