Formal Contracts, Relational Contracts, and the Holdup Problem

53 Pages Posted: 12 Sep 2004

See all articles by Hideshi Itoh

Hideshi Itoh

Waseda Business School; CESifo (Center for Economic Studies and Ifo Institute)

Hodaka Morita

Hitotsubashi University - Institute of Economic Research

Date Written: August 4, 2006

Abstract

We study the holdup problem in repeated transactions between a seller and a buyer such that the seller makes relation-specific investments in each period. We show that where, under spot transaction, formal contracts have no value because of the cooperative nature of investment, writing a simple fixed-price contract can be valuable under repeated transactions: There is a range of parameter values in which a higher investment can be implemented only if a formal price contract is written and combined with a relational contract. We also show that there are cases in which not writing a formal contract but entirely relying on a relational contract increases the total surplus of the buyer and the seller. The key condition is how the investment affects the renegotiation price in general, and the alternative-use value in particular.

Keywords: Holdup problem, formal contract, relational contract, cooperative investment, fixed-price contract, relation-specific investment, renegotiation, repeated transaction, long-term relationships

JEL Classification: D23, L14, L22, L24

Suggested Citation

Itoh, Hideshi and Itoh, Hideshi and Morita, Hodaka, Formal Contracts, Relational Contracts, and the Holdup Problem (August 4, 2006). Available at SSRN: https://ssrn.com/abstract=588041 or http://dx.doi.org/10.2139/ssrn.588041

Hideshi Itoh (Contact Author)

Waseda Business School ( email )

1-6-1 Nishi-Waseda
Shinjuku-ku
Tokyo, Tokyo 169-8050
Japan

HOME PAGE: http://https://www.waseda.jp/fcom/wbs/en

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Hodaka Morita

Hitotsubashi University - Institute of Economic Research ( email )

2-1 Naka Kunitachi-shi
Tokyo 186-8306
Japan

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