Cooperative Investments and the Value of Contracting

Abstract

Recent articles have shown that contracts can support the efficient outcome for bilateral trade, even in the face of specific investments and incomplete contracting. These studies typically considered “selfish” investments that benefit the investor (e.g., the seller's investment reduces her production costs). We find very different results for “cooperative” investments that directly benefit the investor's partner (e.g., the seller's investment improves the buyer's value of the good). Most importantly, if committing not to renegotiate the contract is impossible, then contracting has no value, i.e., the parties cannot do better than to abandon contracting altogether in favor of ex post negotiation. (JEL C70, J41, K12, L22)