Uncertainty and Specific Investment with Weak Contract Enforcement

The relationship between price uncertainty and specific investment is examined in a dynamic model that integrates the theories of real options and investment holdup. Because of weak contract enforcement, bilateral firms cannot use a contract to govern their bilateral investment and exchange relationship. These firms instead rely on an implicit self-enforcing agreement, and they reduce the investment distortion by negotiating an ex ante transfer (i.e., the investment expense of one firm is partially paid for by the other firm). In the absence of uncertainty, the ex ante transfer ensures that investment hold-up is fully eliminated. Our main result is that uncertainty introduces an inefficiency into the ex ante transfer bargaining game, which in turn causes an inefficiently long delay in investment. This linkage between higher uncertainty and longer inefficient investment delay has particular relevance for developing and transition economies where high uncertainty and weak contract enforcement is common.


Issue Date:
2006
Publication Type:
Conference Paper/ Presentation
PURL Identifier:
http://purl.umn.edu/21044
Total Pages:
29
Series Statement:
Selected Paper




 Record created 2017-04-01, last modified 2017-08-24

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