Relationship-Specific Investment and Hold-Up Problems in Supply Chains: Theory and Experiments

Business Research, 12(1), 2019, 45-74.

Posted: 13 Apr 2020

See all articles by Ernan Haruvy

Ernan Haruvy

University of Texas at Dallas - Naveen Jindal School of Management

Elena Katok

University of Texas at Dallas

Zhongwen Ma

affiliation not provided to SSRN

Suresh Sethi

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: March 24, 2019

Abstract

Supply chains today routinely use third parties for many strategic activities, such as manufacturing, R&D, or software development. These activities often include relationship-specific investment on the part of the vendor, while final outcomes can be uncertain. Therefore, writing complete contracts for such arrangements is often not feasible, but incomplete contracts, especially when relationship- specific investment is required, may leave the supplier vulnerable to a version of the ‘‘hold-up problem,’’ which is known to result in sub-optimal levels of investment. We model the phenomenon as a sequential move game with asymmetric information. Absent behavioral considerations, the unique Perfect Bayesian Equilibrium implies zero investment. However, with social preferences, the hold-up problem may be mitigated. We propose a model that incorporates social preferences and random errors, and solve for the equilibrium. In addition, we look at reputation and find it to be effective for increasing investment. We conduct laboratory experiments with human subjects and find that a model with social preferences and random errors organizes our data well.

Keywords: Supply chain contracts, Behavioral economics, Game theory

JEL Classification: C61, C71, C73, M30, M11, M20, M31, M37, Z33

Suggested Citation

Haruvy, Ernan and Katok, Elena and Ma, Zhongwen and Sethi, Suresh, Relationship-Specific Investment and Hold-Up Problems in Supply Chains: Theory and Experiments (March 24, 2019). Business Research, 12(1), 2019, 45-74., Available at SSRN: https://ssrn.com/abstract=3560590

Ernan Haruvy

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

Elena Katok

University of Texas at Dallas ( email )

Jindal School of Management
800 W. Campbell Dr.
Richardson, TX 75080
United States

HOME PAGE: http://www.utdallas.edu/~ekatok/

Zhongwen Ma

affiliation not provided to SSRN

Suresh Sethi (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

800 W. Campbell Road, SM30
Richardson, TX 75080-3021
United States

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