Working Paper: CEPR ID: DP7205
Authors: Eva I. Hoppe; Patrick W. Schmitz
Abstract: In the contract-theoretic literature, there is a vital debate about whether contracts can mitigate the hold-up problem when renegotiation cannot be prevented. Ultimately, the question has to be answered empirically. As a first step in that direction, we have conducted a laboratory experiment with 490 participants. We consider "cooperative" investments that directly benefit the non-investing party. While according to standard theory, contracting would be useless if renegotiation cannot be ruled out, we find that option contracts significantly improve investment incentives compared to a no-contract treatment. This finding can be explained by Hart and Moore?s (2008) notion that contracts may serve as reference points.
Keywords: experiment; holdup problem; option contracts; renegotiation
JEL Codes: C72; C91; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| No contract (K12) | Fixed-price contract (D86) |
| Option contract (G13) | No contract (K12) |
| Option contract with renegotiation (G13) | No contract (K12) |
| Option contract (G13) | Investment incentives (G31) |
| Option contract with renegotiation (G13) | Investment incentives (G31) |
| Fixed-price contract (D86) | Investment incentives (G31) |
| No contract (K12) | High investment (G31) |
| Option contract with renegotiation (G13) | Average profits (D33) |