August 2006
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 transactions, long-term relationships
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Hideshi Itoh hideshi.itoh@srv.cc.hit-u.ac.jp Hodaka Morita H.Morita@unsw.edu.au
