The Holdout Problem and Long-Term Contracting

33 Pages Posted: 26 Sep 2007

See all articles by Alexander Raskovich

Alexander Raskovich

U.S. Department of Justice - Economic Analysis Group

Date Written: September 2007

Abstract

The holdup problem of under-investment in specific capital has been studied extensively. Less attention has been paid to the "holdout" problem of over-investment in outside options. A buyer's gain from (unverifiably) developing an outside option exceeds the joint gain, given rent shifting when an inferior option binds in subsequent bargaining with the seller. Long-term contracts can solve holdout by increasing the buyer's surplus from trade within the relationship. With a nonbinding contract, however, the seller's participation constraint may require the buyer (who may be financially constrained) to pay a large signing bonus. This suggests a novel motive for vertical integration.

Suggested Citation

Raskovich, Alexander, The Holdout Problem and Long-Term Contracting (September 2007). Available at SSRN: https://ssrn.com/abstract=1016766 or http://dx.doi.org/10.2139/ssrn.1016766

Alexander Raskovich (Contact Author)

U.S. Department of Justice - Economic Analysis Group ( email )

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