Contract, Renegotiation, and Hold Up: General Results on the Technology of Trade and Investment

This paper examines a class of contractual relationships with specific investment, a non-durable trading opportunity, and renegotiation. FurtheringWatson’s (2007) line of analysis, trade actions are modeled as individual and trade-action-based option contracts are explored. Simple tools are developed for calculating the “punishment values†that determine the sets of implementable post-investment value functions, and two results are proved. The first result establishes that, with ex post renegotiation, constraining parties to use “forcing contracts†(as is implicit in public-action models) implies a strict reduction in the set of implementable value functions. The second result shows that, by using non-forcing contracts, the party without the trade action can be made residual claimant with regard to the investment action. The paper identifies an important distinction, between divided and unified investment and trade actions, that plays an important role in determining whether an efficient outcome is achieved.