The Effect of Sunk Costs on the Outcome of Alternating-Offers Bargaining between Inequity-Averse Agents

Schmalenbach Business Review, Vol. 58, April 2006

20 Pages Posted: 3 May 2006

See all articles by Christian Ewerhart

Christian Ewerhart

University of Zurich, Department of Economics

Abstract

When investments are specific to a relationship and contracting possibilities are incomplete, the efficiency of a joint venture may be severely impaired by ex-post opportunistic and hold-up type behavior. How is the logic of this argument affected by inequity aversion? In this paper I show that incentives to invest are stronger with inequity aversion because a higher investment by an individual agent increases not only the total surplus to be divided, but also, generally, the relative share of the surplus obtained by this agent in the ex-post negotiation. In fact, when production is sufficiently profitable and agents are sufficiently patient, then first-best investment levels may be approximated without any contract.

Keywords: Alternating-Offers Bargaining, Inequity Aversion, Hold-Up Problem

JEL Classification: C78, L22

Suggested Citation

Ewerhart, Christian, The Effect of Sunk Costs on the Outcome of Alternating-Offers Bargaining between Inequity-Averse Agents. Available at SSRN: https://ssrn.com/abstract=899287

Christian Ewerhart (Contact Author)

University of Zurich, Department of Economics ( email )

Schoenberggasse 1
Zurich, CH-8001
Switzerland

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