Hold-up, Asset Ownership, and Reference Points

We study the trade-off between contractual flexibility and rigidity. Two parties can write a flexible contract that adjusts price to circumstances or a rigid contract that fixes price. A flexible contract leads to argument and shading. A rigid contract gives one party an incentive to hold up the other if value or cost falls outside the normal range. An optimal contract trades off shading and hold-up costs. Asset ownership can help. If one party owns a key asset, his outside option will be high when his value from trade is high. This reduces both shading and hold-up costs.

For more information, contact Philipp Kircher.