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Investments as signals of outside options

Authors
Journal
Journal of Economic Theory
0022-0531
Publisher
Elsevier
Volume
150
Identifiers
DOI: 10.1016/j.jet.2013.12.001
Keywords
  • Incomplete Contracts
  • Relationship-Specific Investments
  • Hold-Up Problem
  • Signaling Games

Abstract

Abstract Consider a seller who can make an observable but non-contractible investment to improve an intermediate good that is specialized to a particular buyerʼs needs. The buyer then makes a take-it-or-leave-it offer to the seller. The seller has private information about the fraction of the ex post surplus that he can realize on his own. Compared to a situation with complete information, additional investment incentives are generated by the sellerʼs desire to pretend a strong outside option. On the other hand, ex post efficiency is not attained since asymmetric information at the bargaining stage sometimes leads to inefficient separations.

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