Formal Contracts, Relational Contracts, and the Holdup Problem

53 Pages Posted: 12 Sep 2004

See all articles by Hideshi Itoh

Hideshi Itoh

Waseda Business School; CESifo (Center for Economic Studies and Ifo Institute)

Hodaka Morita

Hitotsubashi University - Institute of Economic Research

Date Written: August 4, 2006

Abstract

We study the holdup problem in repeated transactions between a seller and a buyer such that the seller makes relation-specific investments in each period. We show that where, under spot transaction, formal contracts have no value because of the cooperative nature of investment, writing a simple fixed-price contract can be valuable under repeated transactions: There is a range of parameter values in which a higher investment can be implemented only if a formal price contract is written and combined with a relational contract. We also show that there are cases in which not writing a formal contract but entirely relying on a relational contract increases the total surplus of the buyer and the seller. The key condition is how the investment affects the renegotiation price in general, and the alternative-use value in particular.

Keywords: Holdup problem, formal contract, relational contract, cooperative investment, fixed-price contract, relation-specific investment, renegotiation, repeated transaction, long-term relationships

JEL Classification: D23, L14, L22, L24

Suggested Citation

Itoh, Hideshi and Itoh, Hideshi and Morita, Hodaka, Formal Contracts, Relational Contracts, and the Holdup Problem (August 4, 2006). CESifo Working Paper Series No. 1786, Available at SSRN: https://ssrn.com/abstract=588041 or http://dx.doi.org/10.2139/ssrn.588041

Hideshi Itoh (Contact Author)

Waseda Business School ( email )

1-6-1 Nishi-Waseda
Shinjuku-ku
Tokyo, Tokyo 169-8050
Japan

HOME PAGE: http://https://www.waseda.jp/fcom/wbs/en

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Hodaka Morita

Hitotsubashi University - Institute of Economic Research ( email )

2-1 Naka Kunitachi-shi
Tokyo 186-8306
Japan

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