Hold-Up Cost and Firm Boundaries

This study introduces a hold-up cost (i.e., the cost of acquiring information regarding a transacting partner's relationship-specific investment to substantiate the need for contract renegotiation) in the model of the property-rights theory. As is widely accepted, the costs of accessing relevant information are economized within firms; integration is assumed to enjoy lower hold-up cost compared to non-integrated ownership structures. We show that significant hold-up cost economization within firms leads to the optimality of non-integrated structures, including joint ownership. Our result explains why radical innovations, regarding which information is hard to convey, can be optimally pursued under a non-integrated structure