Completely relationship-specific investments, transaction costs, and the property rights theory

Author / Creator

Schmitz, Patrick, author

Available as

Online

Summary

In the property rights approach to the theory of the firm, ownership matters if parties have to make partly relationship-specific investments, but ownership would be irrelevant if the investments w...

In the property rights approach to the theory of the firm, ownership matters if parties have to make partly relationship-specific investments, but ownership would be irrelevant if the investments were completely relationship-specific. We show that if negotiations after the investment stage require transaction costs to be paid, then ownership matters even when investments are completely relationship-specific. While in the standard model without transaction costs there are underinvestments compared to the first-best benchmark, in our setting a party may overinvest in order to induce the other party to incur the transaction costs that are necessary to enter the negotiation stage.

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