Patrick W. Schmitz

On the joint use of liability and safety regulation

The efficiency of two different means of controlling hazardous economic activities, namely ex post liability for harm done and ex ante safety regulation, is re-examined. Some researchers have stressed that the complementary use of these two instruments can be socially advantageous. Here it is argued that the models which have been built in order to support this view crucially depend on the assumption that there are persistent enforcement errors. It is demonstrated that such a rather unsatisfactory assumption is not needed if wealth varies among injurers.

The Hold-up Problem and Incomplete Contracts: A Survey of Recent Topics in Contract Theory

This article provides a nontechnical survey on recent topics in the theory of contracts. The hold-up problem is presented and the incomplete contracts approach is discussed. Emphasis is put on conceptual problems and open questions that await further research. Copyright 2001 by Blackwell Publishing Ltd and the Board of Trustees of the Bulletin of Economic Research

Information Gathering, Transaction Costs, and the Property Rights Approach

The property rights approach to the theory of the firm suggests that ownership structures are chosen in order to provide ex ante investment incentives, while bargaining is ex post efficient. In contrast, transaction cost economics emphasizes ex post inefficiencies. In the present paper, a party may invest and acquire private information about the default payoff that it can realize on its own. Inefficient rent seeking can overturn prominent implications of the property rights theory. In particular, ownership by party B may be optimal, even though only the indispensable party A makes an investment decision.

Reserve Prices in Auctions as Reference Points

We consider second-price and first-price auctions in the symmetric independent private values framework. We modify the standard model by the assumption that the bidders have reference-based utility, where a publicly announced reserve price has some influence on the reference point. It turns out that the sellers optimal reserve price increases with the number of bidders. Also in contrast to the standard model, we find that secret reserve prices can outperform public reserve prices, and that setting the optimal reserve price can be more valuable for the seller than attracting additional bidders.

Public-Private Partnerships versus Traditional Procurement: Innovation Incentives and Information Gathering

A government agency wants a facility to be built and managed to provide a public service. Two different modes of provision are considered. In a public-private partnership, the tasks of building and managing are bundled, whereas under traditional procurement, these tasks are delegated to separate private contractors. The two provision modes differ in their incentives to innovate and to gather private information about future costs to adapt the service provision to changing circumstances. The government agencys preferred mode of provision depends on the information gathering costs, the costs of innovation efforts, and on the degree to which effort is contractible.

Can Contracts Solve the Hold-Up Problem? Experimental Evidence

In the contract-theoretic literature, there is a vital debate about whether contracts can mitigate the hold-up problem, in particular when renegotiation cannot be prevented. Ultimately, this question has to be answered empirically. As a first step, we have conducted a laboratory experiment with 960 participants. We consider investments that directly benefit the non-investing party. While according to standard theory, contracting would be useless if renegotiation cannot be ruled out, we find that option contracts significantly improve investment incentives compared to a no-contract treatment. This finding might be attributed to Hart and Moores (2008) recent idea that contracts can serve as reference points.

Optimal allocation of ownership rights in dynamic R&D alliances

We explore the dynamic evolution of property rights regimes in R&D alliances using the incomplete contract approach pioneered by Grossman, Hart and Moore. In contrast to the standard analysis, the productive asset is an excludable public good such as a patent. Moreover, both firms can decide whether to disclose their know-how and invest effort. Know-how that has once been released cannot be concealed later. We characterize different scenarios in which the optimal ownership structure may change over time due to a trade-off between inducing know-how disclosure and ensuring maximum effort.

On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems

A buyer and a seller can exchange one unit of an indivisible good. While producing the good, the seller can exert unobservable effort (hidden action). Then the buyer realizes whether his valuation is high or low, which stochastically depends upon the sellers effort level (hidden information). The parties are risk neutral, they can rule out renegotiation and write complete contracts. It is shown that the first best cannot be achieved whenever the ex post efficient trade decision is trivial. The second-best contract is characterized and an application of the model to the choice of risky projects is briefly discussed.

Know-How Disclosure and Incomplete Contracts

When two parties invest in human capital and at the same time decide on know-how disclosure it can be shown that joint ownership with veto power is the optimal ownership structure, given that only incomplete contracts can be written.

On synergies and vertical integration

We analyze in an incomplete contracts model whether a supplier should be integrated if in addition to his investment level he may choose the intensity of specialization towards the needs of the buyer. A basic trade-off arises: While non-integration may lead to higher investment incentives, potential synergies are foregone. Hence, integration may be optimal even though only the supplier has to make an investment decision. Furthermore we show that if in addition to asset ownership the degree of specialization is contractible both parties will deliberately agree on an inefficiently low level of specialization since this improves investment incentives.