Option Contracts and Renegotiation: A Solution to the Hold-up Problem

Nöldeke, Georg; Schmidt, Klaus M.

doi:10.2307/2555911

Cited by 387 publications

(197 citation statements)

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“…Several papers including Aghion, Dewatripont, and Rey (1994), Nöldeke and Schmidt (1995), and Edlin and Reichelstein (1996) show that simple contracts cum renegotiation can be used to implement the first best under fairly general conditions. However, if the renegotiation outcome is inefficient because the parties suffer from loss aversion, first best efficiency cannot be achieved any more.…”

Section: Asset Ownership Long-term Contracts and The Hold-up Problemmentioning

confidence: 99%

Loss Aversion and Inefficient Renegotiation

Herweg

Schmidt

2014

The Review of Economic Studies

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Abstract: We propose a theory of inefficient renegotiation that is based on loss aversion. When two parties write a long-term contract that has to be renegotiated after the realization of the state of the world, they take the initial contract as a reference point to which they compare gains and losses of the renegotiated transaction. We show that loss aversion makes the renegotiated outcome sticky and materially inefficient. The theory has important implications for the optimal design of long-term contracts. First, it explains why parties often abstain from writing a beneficial long-term contract or why some contracts specify transactions that are never ex post efficient. Second, it shows under what conditions parties should rely on the allocation of ownership rights to protect relationship-specific investments rather than writing a specific performance contract. Third, it shows that employment contracts can be strictly optimal even if parties are free to renegotiate. Terms of use: Documents in EconStor mayJEL classification numbers: C78; D03; D86.

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Section: Asset Ownership Long-term Contracts and The Hold-up Problemmentioning

confidence: 99%

Loss Aversion and Inefficient Renegotiation

Herweg

Schmidt

2014

The Review of Economic Studies

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“…Therefore, they are paying a cost for the benefits they are receiving. With regard to the hold up problem, the parties could enter a simple option contract (Nöldeke and Schmidt, 1995;Lyon and Rasmusen, 2004). Here the buyer is assumed to be the party subject to the hold up.…”

Section: Literature Reviewmentioning

confidence: 99%

Recycling procurement strategies with variable yield suppliers

Rowe

Ekşioğlu

2015

Ann Oper Res

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Companies are no longer judged on financial performance alone, but rather on their "Triple-Bottom Line", which accounts for social and environmental measures as well. This leads companies to investigate the sustainability of their operations and their products. Between the increasing cost of virgin raw materials and customers demanding post-consumer product content, manufacturers have begun looking at recycled material options. This paper addresses a procurement issue facing a polystyrene packaging manufacturer considering its optimal purchasing strategies between two suppliers -one providing virgin material, the other offering recycled material. A single-period scenario is modeled where each supplier sells product with a known yield distribution at market pricing. The manufacturer must choose whether to sole-source or dual-source, as well as determine how much material to purchase from each supplier to meet deterministic demand. Our results indicate that there is a range of prices from the recycled material supplier where dual-sourcing will lead to higher manufacturer profits compared to solesourcing. We show, based on the procurement strategy, the optimal quantities to purchase to maximize manufacturer's expected profit.We then investigate the area of supplier development and how the manufacturer can improve their expected profit by investing in their supplier's quality improvement effort. The questions addressed are how much the manufacturer would be willing to invest and how they ensure the proper return on their investment. This paper determines the expected increase in profit for the manufacturer from yield improvement projects at a supplier, which therefore becomes the upper threshold for investment. We also find that a company can err in their project acceptance criteria if they have an approval process that views project acceptance myopically rather than holistically.Lastly, we develop a systematic and comprehensive approach to the supplier selection process. We utilize the fundamental concepts behind W. Edwards Deming's Plan-Do-Study-Act improvement cycle and apply them to the supplier selection process.We also present analytic and numerical study results that can be used in conjunction with contractual mechanisms to not only overcome issues such as free riding, but to also incentivize suppliers to engage in supplier development projects they may not have otherwise undertaken. In order to understand why companies have become more attentive to the issue of recycling, one must look back over the past few decades. Firms have faced increased scrutiny on the environmental impact surrounding the disposal of consumer goods, the disposition of production by-products, and how they act as corporate citizens. No longer are companies judged solely on their financial measurements. They are now being evaluated on the "Triple Bottom Line". This metric measures a firm's social and environmental performance, as well as its economic performance. Manufacturers must 2 now address how their products impact the environment...

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“…See Nöldeke and Schmidt (1995) and Maskin and Tirole (1999). Additionally, in some cases the ex ante determination of the renegotiation design could solve this investment problem, too.…”

Section: Repeated Interactionmentioning

confidence: 99%

The Impact of Electronic Markets on B2B-Relationships

Haller

2004

SSRN Journal

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Abstract. Although most of the predicted consequences of the internet-revolution in the 90s did not become reality, the internet has lead to sustainable changes in the organization of most industries. In particular, this is true for business-to-business (B2B) relations between firm. An obvious 'proof' for this is the rising number of socalled electronic markets-especially for B2B transactions-since several years. This paper should help to give a better understanding of the organizational impacts of electronic markets in the context of B2B relations. Therefore we use the incomplete contract framework to build a simple model of a repeated game. It will be shown that the existence of an (alternative) electronic market could influence the willingness to cooperate between the up-and the downstream firm in a B2B-relationship. In our special case, the willingness to cooperate by the buyer will decline.

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Option Contracts and Renegotiation: A Solution to the Hold-up Problem

Cited by 387 publications

References 0 publications

Loss Aversion and Inefficient Renegotiation

Loss Aversion and Inefficient Renegotiation

Recycling procurement strategies with variable yield suppliers

The Impact of Electronic Markets on B2B-Relationships

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