Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/150107
Authors: 
Zhao, Rui R.
Year of Publication: 
2008
Citation: 
[Journal:] Theoretical Economics [ISSN:] 1555-7561 [Volume:] 3 [Year:] 2008 [Issue:] 1 [Pages:] 85-121
Abstract: 
This paper studies bilateral trade in which the seller makes a hidden investment that influences the buyer's hidden valuation. In general it is impossible to implement both first-best efficient trade and efficient investment using budget-balanced trading mechanisms. The paper fully characterizes the constrained efficient contracts. It is shown that the optimal tradeoff between allocative efficiency and incentive provision results in rigidity in trade, the degree of which depends on the seriousness of the holdup problem. Sufficient conditions are also provided for full separation of buyer types to take place in optimal contracts when the holdup problem is not too severe. The seller may overinvest relative to the first best.
Subjects: 
Bilateral contracting
hidden action and hidden information
holdup problem
nonlinear pricing
JEL: 
C72
D20
D82
Creative Commons License: 
https://creativecommons.org/licenses/by-nc/3.0
Document Type: 
Article

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