Efficiency Out of Disorder - Contested Ownership in Incomplete Contracts

This paper studies the role of contested ownership in a situation where two players have to make a transaction-specific investment and when contracts are incomplete. It compares contested ownership to the various ex ante ownership structures typically discussed in the literature (following the influential work by Grossman, Hart, and Moore). The paper shows that contested ownership mitigates the inefficiency of investments due to the incompleteness of contracts generating an exchange surplus which comes closer to the first-best surplus as compared to any other ex ante distribution of ownership. With a perfectly discriminatory contest technology (all-pay auction), each player makes a transaction-specific investment as if he or she owns the asset. This paper can explain why high-tech firms that involve highly transaction-specific investments in skill of a group of engineers - as for example Hewlett Packard - often start as partnerships