Market-induced Asset Specificity: Redefining the Hold-up Problem

Abstract

In a standard hold-up problem, individuals are vulnerable to hold-up because it is impossible to write complete contracts to cover the lifespan of relationship-specific investments. Hold-up occurs only when investments are to some degree nongeneric, and the extent of the problem increases with the time-span over which an investment must pay off, since long-term contracts are more difficult to write than short-term contracts. This result appears inconsistent with the real life experience of contract suppliers in two respects. First, suppliers often consider themselves "vulnerable" to hold-up even when investments are generic. Second, such a sense of vulnerability is often greatest precisely when assets are short-lived rather than long-lived. This paper provides a model that solves this apparent paradox by looking beyond the isolated problem of bilateral monopoly to the market context in which contracting takes place. We then find that the very meaning of asset specificity comes into question.