Relationship-specific investment and hold-up problems in supply chains: theory and experiments

Abstract

Supply chains today routinely use third parties for many strategic activities, such as manufacturing, R&D, or software development. These activities often include relationship-specific investment on the part of the vendor, while final outcomes can be uncertain. Therefore, writing complete contracts for such arrangements is often not feasible, but incomplete contracts, especially when relationship-specific investment is required, may leave the supplier vulnerable to a version of the ''hold-up problem,'' which is known to result in sub-optimal levels of investment. We model the phenomenon as a sequential move game with asymmetric information. Absent behavioral considerations, the unique Perfect Bayesian Equilibrium implies zero investment. However, with social preferences, the holdup problem may be mitigated. We propose a model that incorporates social preferences and random errors, and solve for the equilibrium. In addition, we look at reputation and find it to be effective for increasing investment. We conduct laboratory experiments with human subjects and find that a model with social preferences and random errors organizes our data well.

A Survey of the Hold‐up Problem in the Experimental Economics Literature

“…The ultimatum game, where one player proposes an allocation and the other player decides whether to accept or to reject, can be regarded as an extreme case of the Rubinstein alternating offer bargain with only one round of offer. It is common in most recent hold‐up experiments (Ellingsen and Johannesson, 2004b; Sloof et al ., 2007; Hoppe and Schmitz, 2011; Morita and Servátka, 2013, 2018; Haruvy et al ., 2019; Zheng et al ., 2020) to adopt a unilateral investment with a binary investment choice followed by an ultimatum bargaining stage where the noninvestor proposes an allocation and the investor decides whether to accept or to reject. Rejection leads to zero payoffs to both parties.…”

“…In the bargaining stage, evidence also shows that exploitation of the investors is less severe than the standard self‐interest prediction. In experiments where only one party is allowed to make an offer in the bargaining stage, namely, the experiments using an ultimatum game (Gantner et al ., 2001; Ellingsen and Johannesson, 2004b; Hoppe and Schmitz, 2011; Morita and Servátka, 2013, 2018; Haruvy et al ., 2019; Zheng et al ., 2020) or a dictator game (Berg et al ., 1995; Fehr and List, 2004; Charness and Dufwenberg, 2006; Sloof et al ., 2007; Charness and Dufwenberg, 2010; Charness et al ., 2011; Huck et al ., 2012; Eisenkopf and Nüesch, 2016; Ismayilov and Potters, 2016; Eisenkopf and Nüesch, 2017) as the bargaining mechanism, the proposer offers a positive amount to the partner under most circumstances. In the experiment by Ellingsen and Johannesson (2004b), the most common offer by the proposer is one that allocates equal net profit to both parties, chosen by almost 50% of the proposers.…”

On the current state of combining human and artificial intelligence for strategic organizational decision making

“…The former category refers to applications that are created implicitly, meaning that they all statistically learn from experience and are thus not completely predictable, error-free, or explainable. The second cluster includes mathematical and statistical approaches, although researchers sometimes do not agree with or even mention them as being AI (e.g., Simon 1995;Welter et al 2013;Haruvy et al 2019). These applications are also called logical rules and knowledge representation, based on rules that human programmers provide to computers, often with the goal of automation (Surden 2019), leading to systems that are predictable and explainable with strict and known abilities (Bolander 2019).…”

Buyer–Supplier Contract Length and the Innovation of Supplier Firms

“…Nonetheless, contracts that specify such a condition tend to require a fixed investment beforehand. This type of investment can include the audit of the technical efficiency and financial ability of the supplier, and in certain cases require the buyer's aids in building up the technology and capital capacity to match the specific requirements of the buyer [1,7].…”