Abstract
A seller can make investments that affect a tradable asset’s future returns. The potential buyer of the asset cannot observe the seller’s investment prior to trade, nor does he receive any signal of it, nor can he verify it in anyway after trade. Despite this severe moral hazard problem, this paper shows the seller will invest with positive probability in equilibrium. The outcome of the game is sensitive to the distribution of bargaining power between the parties, with a holdup problem existing if the buyer has the bargaining power. A consequence of the holdup problem is welfare-reducing distortions in investment level, but not necessarily a reduction in the expected amount invested vis-a-vis the situation without holdup.
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