Incomplete Contracts and the Use of Options to Prevent Hold-Up in Investments Under Uncertainty

Publikation: Working paperForskning

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I consider the unilateral investment problem, in which a principal makes an asset specific investment not knowing the quality of the asset at the time of investing, and not knowing if the asset will end up being most productive if owned by the principal or not. The paper shows that unconditional ownership cannot provide first-best incentives for investment. A striking result is that giving the principal ownership leads to overinvestment, even without the investment affecting his outside option. In some cases first-best incentives for investment can be provided using an option contract where the principal after observing the quality of the asset is given the option to buy it at a pre-negotiated price.
UdgiverDepartment of Economics. Copenhagen Business School
Antal sider14
StatusUdgivet - 1998
Udgivet eksterntJa
NavnWorking Paper / Department of Economics. Copenhagen Business School

Bibliografisk note

This paper was presented at Copenhagen Business School under the title "Incomplete Contracts and Adverse Selection"