Investment in Outside Options as Opportunistic Behavior: An Experimental Investigation

Abstract

Ex‐post opportunistic behavior, commonly present in bilateral trade relationships, is a key element of the transaction cost economics. Investment in outside options is a prime example of such opportunism and often leads to inefficiency, for example by exerting effort to search for alternative business partners even if it does not add trade value. We experimentally investigate a bilateral trade relationship in which standard theory assuming self‐regarding preferences predicts that the seller will be better off by investing in the outside option to improve his bargaining position. The seller's investment, however, might negatively affect the buyer's other‐regarding preferences if the investment is viewed as opportunistic. We find overall support for our hypotheses that arise from the link between other‐regarding behavior and opportunism. Our findings suggest that when the transaction cost economics approach is applied to the design of a governance structure, other‐regarding preferences should be taken into account.