NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Holdups, Standard Breach Remedies, and Optimal Investment

Aaron S. Edlin, Stefan Reichelstein

NBER Working Paper No. 5007 (Also Reprint No. r2113)
Issued in February 1995
NBER Program(s):   LE

We consider a bilateral trading problem in which one or both parties makes relationship-specific investments before trade. Without adequate contractual protection, the prospect of later holdups discourages investment. We postulate that the parties can sign noncontingent contracts prior to investing, and can freely renegotiate them after uncertainty about the desirability of trade is resolved. We find that such contracts can induce one party to invest efficiently when either a breach remedy of specific performance or expectation damages is applied. Specific performance can also induce both parties to invest efficiently, provided a separability condition holds. In contrast, expectation damages is poorly suited to solve bilateral investment problems.

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Document Object Identifier (DOI): 10.3386/w5007

Published: American Economic Review, vol. 86, no. 3, pp. 478-501, June 1996. citation courtesy of

 
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