Since the
influential paper by Klein et al. (1978), there has been an extensive literature
explaining economic institutions in terms of their reducing transactions costs for
"post-contractual opportunistic behavior": the hold-up problem. When one party
transacts with another, it often involves some relationship-specific investment. Since
contracts are incomplete, they have to rely on bargaining to divide the surplus of
investment. Typically, however, the party who makes this ex ante investment is not
its residual claimant because she does not have all the bargaining power at the ex post
bargaining stage. Knowing that her sunk cost of investment will not be fully
compensated, she will under-invest. Even though agents have private information in
virtually every real-world example involving this classic phenomenon, "[a]symmetric
information has played a very limited role in the analysis of the hold-up problem"
(Hart, 1995). In the bulk of the existing incomplete-contract literature, all the
variables of interest are assumed to be observable among the parties at the
bargaining stage. Such a simplifying assumption is particularly problematic in the large
literature where the hold-up problem involves human-capital investment. Even if investment
is physical, the degree to which it is non-adjustable may be private knowledge.
In this dissertation, I study the hold-up problem with varying degrees of information
asymmetry. This allows me to characterize the sensitivity of the equilibrium outcome to
information, and hence identify the optimal information structure. My analysis provides a
basis for institutional design, and sheds light on the robustness of existing
incomplete-contract models.
Information and Bargaining in the Hold-Up Problem (job market paper)
This paper incorporates an information structure with partial information into
the canonical hold-up problem with one-shot bargaining. Gibbons (1992) and Gul (2001) have
both shown that the parties jointly obtain the lowest surplus with either no
information or full information. By varying the degree of information between the
parties, I show that their joint surplus varies non-monotonically with information
asymmetry. The key observation is that asymmetric information introduces two
counterbalancing forces. On the one hand, it increases the inefficiency due to
disagreement from ex post bargaining. On the other, the information rents created
give rise to more investment incentives, lowering the inefficiency due to ex ante
under-investment. Within a wide range of information structures, the joint surplus is
strictly higher than that under full information or no information. Put differently, the
optimal information structure occurs at an intermediate level of information asymmetry.
Therefore, it is misleading to focus solely on the two polar cases.
I further extend the model to infinite-horizon repeated bargaining. In this dynamic
context, "bargaining disagreement" is replaced by "bargaining delay".
However, as the time between successive offers goes to zero, repeated bargaining kills off
any delay, thereby reinforcing the investment incentives due to information rents.
Consequently, the joint surplus unambiguously increases with information asymmetry.
Furthermore, the first-best outcome can only be achieved under the extreme case of
perfect asymmetry (no information), while the lowest joint surplus is obtained for a wide
range of information structures. This invalidates Gul’s (2001) conjecture that
"a small amount of asymmetric information between the buyer and the seller regarding
the buyer's investment level may be sufficient" to achieve the socially efficient
outcome. As a by-product, I demonstrate that the possibility of repeated bargaining is
never Pareto impairing.
This paper confirms that asymmetric information, the parameter that has been frequently
ignored in the literature, turns out to be an important welfare instrument in the hold-up
problem. Its implications are two-fold. First, since the optimal information structure
depends crucially on whether bargaining is one-shot or repeated, use of this instrument
should depend on the nature of the situation. In particular, if the good being traded is
perishable and there is no room for repeated bargaining, then the optimal institution will
involve an intermediate level of information asymmetry. On the other hand, where repeated
bargaining is viable, it will be desirable to ensure its feasibility and limit information
flow to the greatest possible extent. This optimal flow of information can be achieved,
for example, by adjusting legal disclosure rules for firms. Second, departing from the
full information assumption that is prevalent in the incomplete-contract literature in
general gives a distinct prediction regarding the optimal allocation of ownership. More
startlingly, an immediate consequence of my results is that it may be optimal to assign
ownership to the party with less information.
Optimal Information Structures in the Static Hold-Up Problem
In the previous paper, the format of information asymmetry is taken from a standard
class of information structures. In this study, I characterize the optimal information
structures of the static hold-up problem, allowing for any noisy information structure. I
establish the following properties regarding the optimal information structures: (i) they
consist solely of informative signals; (ii) they do not induce "bargaining
disagreement" in equilibrium; (iii) for some simple cases, the monotone likelihood
ratio property emerges endogenously.
Repeated Hold-Up Problem with Imperfect Monitoring (in progress)
Many long-term relationships involve not only repeated transactions, but also periodic
specific investments. In the spirit of my dissertation, investments are not always
observable and parties have to rely on commonly observable signals to provide reward and
punishment for investments. In this work that is currently in progress, I formulate an
ongoing specific relationship as a repeated game with imperfect monitoring. This enables
me to add the additional twist of reputation effect, and analyze its interactions with the
"information rent" and "bargaining disagreement" effects that are
central in the static hold-up problem with asymmetric information.
Uncovering the Private Cost Distributions in CDOT Procurement Auctions
In this paper, I construct a dataset from Colorado’s highway procurement auctions
and use a two-step non-parametric approach to estimate the private cost distributions of
contractors bidding in these auctions. I find evidence supporting the game-theoretic model
widely employed in the literature. With the distributions uncovered, I compute the interim
profits of these firms, and evaluate the impact of geographic location and capacity
constraints on their bidding behavior. |