Opportunism in Sequential Investment Settings: On Holdups and Holdouts

The holdup and holdout problems arise in different contexts, but they share certain fundamental similarities that have not generally been recognized. In particular, both involve activities requiring an up-front, non-salvageable investment, and both require the investor to purchase an input, the price of which is determined by bargaining after the initial investment has been made. The effect of the up-front investment is to reduce the investor’s bargaining power with the seller of the input. The anticipation of the outcome of this bargaining creates a disincentive for the investor to undertake the project in the first place, causing some efficient projects to be foregone. Remedies for the two problems, though outwardly different, share features that reflect the common source of their inefficiency.