Cooperative Investment and the Value of Contracting with Transaction Costs

Abstract

Bilateral exchange and asset specific investments are becoming increasingly common as agricultural markets continue to industrialize and become vertical coordinated. The extent that well-designed contracts can prevent investment “holdup” in bilateral exchange situations has been examined extensively in the general economics literature. Che and Hausch (1999) established the strong result that contracts have no value if the relationship specific investment is purely cooperative and if the contracting parties cannot commit to not renegotiate the contract ex post. In this paper, it is shown that contracts are generally valuable in a Che and Hausch environment if information between the seller and buyer is asymmetric and there is a cost to eliminating this asymmetry.