Hold-Up, Asset Ownership, and Reference Points*

Abstract

This paper reexamines some of the themes of the incomplete contracts literature—in particular, the hold-up problem and asset ownership—through a new theoretical lens, the idea that contracts serve as reference points (see Hart and Moore [2008]). We consider a buyer and seller who are involved in a (long-term) economic relationship where the buyer’s value and seller’s cost are initially uncertain. For the relationship to work out, the parties need to cooperate in ways that cannot be specified in an initial contract. Suppose that the parties write a rigid contract that fixes price. Such a contract works well in “normal” times because there is nothing to argue about: we assume that, in the absence of argument, the parties are willing to cooperate. However, if value or cost falls outside the normal range, one party will have an incentive to threaten to withhold cooperation unless the contract is renegotiated; that is, the party will engage in hold-up. For example, if value is unusually high, the seller will hold up the buyer to get a higher price, whereas if cost is unusually low, the buyer will hold up the seller to get a lower price. We suppose that hold-up transforms a friendly relationship into a hostile one. The consequence is that the parties withhold cooperation: they operate within the letter, rather than the spirit, of their (renegotiated) ∗ I am grateful to John Moore for discussions of some of the elements of this paper and to Bob Gibbons and Birger Wernerfelt for many helpful conversations. I would also like to thank Ronen Avraham, Mathias Dewatripont, Florian Englmaier, Rob Gertner, Victor Goldberg, Louis Kaplow, Josh Lerner, Bentley MacLeod, Jeremy Stein, Sasha Volokh, Abe Wickelgren, and Christian Zehnder for useful comments, and Georgy Egorov for excellent research assistance. Four referees, an editor (Larry Katz), and a second editor provided highly constructive input. Financial support from the U.S. National Science Foundation through the National Bureau of Economic Research is gratefully acknowledged.