post investment hold up

hbk investments strategies

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Post investment hold up human-capital investments and productivity

Post investment hold up

The initial contract can cover only short-term situations. Eventually, renegotiation is needed, which provides an opportunity for e. S to hold up B. As S knows that the investment is a significant cost to B and tries to use this as leverage to negotiate an increase in its prices. In that case, S has more bargaining power, compared to B, and tries to use it to its own advantage.

The source of power lies in the investment of B. For B it is hard to find out whether or not the raise in prices is reasonable. Even if the outcome would be Pareto efficient , B might not accept the agreement. If the renegotiations turn out to be unsuccessful both parties are worse off: B has made an investment that goes to waste, and S lost a customer. Inefficiency is caused by the hold-up problem when B is reluctant to make the investment ex ante from the fear that S uses its extra bargaining power to its own advantage.

In that case the supplier is 'holding up' the buyer. A historic example concerns the US car industry, but the example is sharply disputed by Coase In , a sharp increase in demand occurred that was above expectations. It is claimed that Fisher Body used the unforeseen situation to hold up GM by increasing the price for the additional parts produced.

It has been said that the hold up led to GM acquiring Fisher Body in During transition out of South African apartheid , many white elites feared that democratization would result in tyranny of the majority. Now that fair elections were held, many wealthy whites feared that the longtime poor blacks or their elected representatives would expropriate wealth from the white minority.

For this reason there was white resistance against democratic and fair elections. To ensure a peaceful transition and to uphold the credibility of the elections , the African National Congress needed to make a commitment to protect the incomes and wealth of the white elites. That credible commitment from the ANC made the new democractic regime sufficiently attractive to whites in South Africa, otherwise they would not have agreed to transition out of autocracy.

Rogerson showed the existence of a first-best contractual solution to the hold-up problem in even extremely complex environments involving x agents with arbitrarily complex transaction decisions and utility functions. He shows that three important environmental assumptions must be made:.

According to Rogerson the hold-up problem does not necessarily create inefficiencies; when it does, one of the above requirements is not satisfied. The requirements are necessary to come to an absolutely best solution. If there are direct externalities and renegotiation cannot be prevented, even under symmetric information, underinvestment cannot be avoided. Such a contract gives the seller the right but not the obligation to deliver a fixed quantity of the good and also makes the contractual payment of the buyer dependent on the delivery decision of the seller.

Thus, this contract does not depend on renegotiation or complicated mechanisms, but its crucial feature is that one of the parties can unilaterally decide whether the trade takes place. However, such a contract is unachievable unless it is possible to enforce the payments conditional on the delivery decision of the seller.

That means that the court must be able to verify delivery of the good to the buyer by the seller. The organization and governance structure of a firm might be seen as a mechanism for dealing with a hold-up problem. A solution to the hold-up problem is vertical integration such as a merger in which all parts of the body are being produced internally rather than outside. In that way, the transaction costs associated with contractually induced hold-ups are saved and also the costs associated with the number of contracts written and executed.

Hold-up problems are created from the existence of firm-specific investments. Whether a vertical integration is adopted as a solution to the hold-up problem depends on the magnitude of the specific investment and the ability to write long-term contracts, flexible enough to avoid a potential hold-up. However, the ability to write flexible long-term contracts strongly depends upon the underlying market uncertainty and the reputation of the company.

Therefore, those factors will also influence the likelihood of vertical integration. While traditional incomplete contracting models of vertical integration such as Grossman and Hart assume symmetric information, Schmitz has extended the incomplete contracting framework to allow for asymmetric information. From Wikipedia, the free encyclopedia. Economic dilemma. Key concepts. Promotional content. Promotional media. Behavioral targeting Brand ambassador Display advertising Drip marketing In-game advertising Mobile advertising Native advertising New media Online advertising Out-of-home advertising Point of sale Product demonstration Promotional merchandise Visual merchandising Web banner Word-of-mouth.

Market research Marketing research Mystery shopping. Each treatment includes four sessions, and each session includes four buyers and four sellers. Participants play the game corresponding to one treatment with payoffs corresponding to Fig. They are randomly re-matched each round. In total, our experiment includes 96 participants.

We recruited participants using ORSEE recruitment system Greiner and offered cash as the only incentive to participate. We designed experimental software using zTree Fischbacher Our design examines the effect of social preferences by comparing impunity and reciprocity conditions. Additionally, we test an intervention that we call reputation, in which we keep track and show to the seller the average number of times the current buyer offered a high price.

In summary, our experiment includes the following three treatments:. In the impunity treatment, participants have access to their own prior history that includes past production decisions, the price offered if production occurred , and their own realized profits.

The buyers have one additional piece of information that sellers do not have—the realized quality for the current and all past periods. Participants have access to the same historical information as in the impunity treatment. In the reputation treatment, the payoffs are the same as in the impunity condition.

Historical information is different. Specifically, sellers see the proportion of the time the buyer with whom the seller is matched during the current period offered a high price; this buyer-specific history is shown to the seller prior to making the production decision. In the impunity treatment, a buyer motivated exclusively by monetary payoff derives his average equilibrium probability of offering high price for high quality according to Eqs.

Buyer expected profit as a function of the probability of offering high price for high quality in the impunity treatment. For a seller concerned with inequality aversion, this threshold would be higher. Hypothesis 1. In the impunity treatment, buyers offer high prices for high quality on average at least Sellers never reject any price offer. The utility from not producing is 2, while the expected utility from producing is. In the reciprocity treatment, rejection is not a dominated action for a seller because even though the seller foregoes 0.

This gives buyers an additional incentive to offer a high price for high quality in the reciprocity treatment. We summarize predictions about the differences between the impunity and reciprocity treatments in the following hypothesis:. Hypothesis 2. In the reciprocity treatment, the frequency of rejections of low prices will be higher than in the impunity treatment, the frequency of high prices for high quality will be higher than in the impunity treatment, and the production rate will be higher than in the impunity treatment.

Therefore, we expect higher proportion of high prices offered for high quality in the reputation treatment than in the impunity treatment, and indeed we can see from comparing Figs. Hypothesis 3 In the reputation treatment, production and high prices for high quality will be higher than in the impunity treatment. Rejections will be similar across the two treatments.

We present summary statistics for production, prices, profits and rejections in the three treatments. We then report estimates for a behavioral model that includes non-monetary preferences and errors. We report standard errors in parenthesis, and we use the session average as a unit of analysis recall that each treatment includes four sessions.

All p values reported are for a t test with four independent session-level observations. We examine the results as they relate to H1 pertaining to the impunity treatment. In fact, the proportion of high prices for high quality is not significantly different from the hypothesized 0.

These aspects of the data are consistent with H1. However, two aspects of the data are not entirely consistent with the theory. However, both are sufficiently small in absolute terms to be attributed to errors as we will show in the model estimation. We now turn our attention to H2, concerned with the comparison of the impunity and reciprocity treatments. H3 is concerned with the comparison of the impunity and reputation treatments.

We find the patterns in the data to be consistent with H3. In Fig. To focus on the trend, we aggregate periods of data into 20 five-period blocks. Rejections and production are highly stable after an initial learning that takes about 20 periods. The proportion of high prices for high quality is quite stable in rounds 21—80, but in the reputation treatment, in contrast to the reciprocity treatment, it exhibits end-game effect in the last 20 rounds.

This is not surprising; other studies also found end-game effects in reputation treatments see for example Bolton et al. In the next section, we report on estimation of a behavioral model using periods 21— for the analysis to eliminate the initial periods of steep learning. We estimate behavioral parameters for sellers only. Because the two decisions are not independent, we estimate them jointly through a joint likelihood function. We assume that in the impunity and the reciprocity treatments, these forecasts are simply the average probability that seller j observed high prices in the past, multiplied by the unconditional probability of high quality.

Note that subscript i does not appear on the right hand side because the seller cannot distinguish among different buyers in the impunity and the reciprocity treatments. We stress that even though the dynamic equilibrium approximation model in Sect. Proportions of high prices for high quality and production rates are lowest in the impunity treatment, highest in the reciprocity treatment, and in between in the reputation treatment.

None of the high price proportions are different from predictions. Proportions of low prices rejected are highest in the reciprocity treatment, lowest in the reputation treatment, and in between in the impunity treatment. None of the rejection rates are significantly different from predictions.

Seller profits are highest in the reciprocity treatment and lowest in the impunity treatment. Buyer profits in the impunity and reciprocity treatments are not significantly different from predictions. A deviation from predictions is that quantitatively the proportion of high prices offered for high quality and production rates are slightly lower than predicted in the reciprocity and reputation treatments.

In fact, there is a good deal of heterogeneity in behavior see Appendix B. Last, inequality aversion appears low although significant in all three treatments. It is possible that inequality aversion is more salient in the reciprocity treatment than in the other two treatments because the seller can implement a fair split by punishing the buyer in that treatment. Saliency of inequality aversion is, however, beyond the scope of this paper.

With the prevalence of using third party vendors for strategic activities, such as manufacturing, by many major firms, the hold-up problem has to be considered as one of the major pitfalls in supply chain management. For example, contract manufacturers take on increasingly sophisticated tasks and activities requiring relationship-specific investments which leave firms on both sides of the transaction more vulnerable to the hold-up problem than ever before. Additionally, incomplete information is typically present in these arrangements because the OEMs and contract manufacturers are often located on different continents and are subject to different cultural norms.

We analyze and test in the laboratory a stylized game designed to highlight the possibility of the hold-up problem due to the relationship-specific investment by the supplier. We derive approximate equilibrium predictions that match the data remarkably well.

In our impunity setting, the analysis predicts limited cooperation but also a large loss in efficiency due to the hold-up problem—predictions that match the data well. We also find, both analytically and empirically, that a setting in which the supplier has the ability to negatively reciprocate, cooperation increases, as does efficiency.

We find that reputation information mitigates the hold-up problem, both analytically and empirically. The managerial implication of our work is that the hold-up problem can be effectively mitigated in settings in which the relationship is not one shot.

Our findings suggest that a systematic way of making this reputation information available mitigates the hold-up problem a great deal. A fruitful direction for future research would be to test other, more sophisticated, reputation system designs. For example, systems that track not just average performance, but also provide information about recent versus past actions, may work even better. It may also be worthwhile to analyze informal arrangements, such as hand-shake agreements, in the context of relationship-specific investments, to learn to what extent they may mitigate the hold-up problem.

The proof hinges on grim-trigger punishment in an infinitely repeated game. Once a partner defects, investment is zero forever after a certain period. The setting is not at all like ours because the principal has multiple partners to choose from, and a rich space of repeated game strategies to employ, but the idea of the game being more than a one-shot is an important component of the present setting, as well as the concept of reputation.

Additionally, buyers could make random errors, which would not affect qualitative predictions, but in all likelihood would make the model fit the data even better. In the estimation section, in which we use the panel data from our experiment, we will add subscripts for seller j and time period t to our notation.

Predicted high prices for high quality are based on solving Eq. Production probability is based on Eq. Rejection rates are based on Eq. Barnes, A, Boeing: Faster, faster, faster: The planemaker struggles to fulfill a rush of orders. Trust, Reciprocity and Social History. Games and Economic Behavior — Board, Simon. Relational Contracts and the Value of Loyalty. American Economic Review December : — Bolton, G. A theory of equity, reciprocity, and competition. American Economics Review 90 1 : — Katok, and A.

How effective are online reputation mechanisms? An experimental study. Management Science 50 11 : — Cooperation among strangers with limited information about reputation. Journal of Public Economics 89 8 : — Camerer, Colin. Princeton: Princeton University Press. Google Scholar. Coase, R. Cooper, D.

In The Handbook of Experimental Economics 2 , eds. Kagel, J. Crocker, K. Cui, T. Raju, and Z. Fairness and channel coordination. Management Science 53 8 : — Cui, Tony Haitao, and Paola Mallucci. Fairness Ideals in Distribution Channels. Journal of Marketing Research 53 6 : — De Bruyn, A. Estimating the influence of fairness on bargaining behavior. Management Science 54 10 : — Dufwenberg, M. Smith, and M. Van Essen. Hold-up: with a Vengeance. Economic Inquiry — Lost Out on iPhone Work.

Accessed 9 June Ellingsen, T. Promises, Threats and Fairness. Economic Journal — Ellingsen, Tore, and Magnus Johannesson. Is There a Hold-up Problem? Scandinavian Journal of Economics 3 : — Fehr, E. A Theory of Fairness, Competition and Cooperation. Quarterly Journal of Economics 3 : — Fischbacher, U. Experimental Economics 10 2 : — Greiner, B.

An online recruitment system for economic experiments. In Forschung und Wissenschaftliches Rechnen. GWDG Bericht 63, ed. Kremer, V. Hackett, S. Journal of Law Economics and Organization 10 4 : — Working paper. Haruvy, E. Li, and S. European Journal of Operational Research 2 : — Hoppe, E. Can contracts solve the hold-up problem? Experimental evidence. Games and Economic Behavior 73 1 : — Katok, E. Fairness in supply chain contracts. Journal of Operations Management — Loch, C.

Social preferences and supply chain performance: An experimental study. Management Science 54 11 : — MacDonald, G. How do value creation and competition determine whether a firm appropriates value? Management Science 50 10 : — McKelvey, R. Games and Economic Behavior 6— Nash, J. Two-person Cooperative Games. Econometrica — Oosterbeek, H. Sonnemans, and S. Mimeo: University of Amsterdam. Zheng, and K. Trust in Forecast Information Sharing. Management Science 57 6 : — Forecast Information Sharing in China and the U.

Reilly S. Federal Times , May 8. Rogerson, W. Contractual Solutions to the Hold-Up Problem. Review of Economic Studies 59 4 : — Schone, M. Sonnemans, J. Sloof, and H. Economic Journal : —

WORKFORCE INVESTMENT ACT COLUMBUS GA

This resolved the hold-up problem and the number of contract disputes decreased, but at the cost of funding a second engine by the US Military. The US Congress has continued to fund the two engines through Schone Other examples of negative and costly consequences that have the hold-up flavor include expensive and protracted lawsuits, such as one between the U. Postal Service and Northrop—Grumman Corp.

Fears of the hold-up problem, on the other hand, result in under-investment by suppliers Haruvy et al. We study incomplete contracts that make one of the players vulnerable to a version of the hold-up problem, using laboratory experiments with human subjects. In the experimental economics literature, the hold-up problem builds on the extensively studied investment game Berg et al.

In the investment game, the first mover—the seller the terms seller and buyer are accepted terminology, e. Investment creates surplus generally in investment game experiments, the surplus to be divided is three times the investment amount—a parameterization not required for the definition of an investment game. The second mover—the buyer—decides how much of the created surplus to expropriate.

There is much room for mutual gain of both parties, but given the sequential nature of the game, it is best response of the buyer to expropriate the entire surplus in a single shot game. By backward induction, the seller will not invest. In numerous experimental studies see overview in Camerer , the general pattern is that sellers do invest and buyers share some of the surplus with the sellers. The setting that we study in this paper is different from the standard investment game in several aspects.

In Dufwenberg et al. As expected, none of the sellers who decided to initially produce chose to reject an unkind offer that results in a gain to the buyer. Ellingsen and Johannesson a run a hold-up game experiment as well using the term hold-up , to study the effect of communication. Their interpretation of what constitutes a hold-up game is the same as Dufwenberg et al. The seller their terminology has seller and buyer first decides whether to invest 60 or not.

Then, the buyer proposes a division of tokens, which is the revenue created by the investment. The seller can then accept or reject. This structure is the same as Dufwenberg et al. The purpose of the experiment was to compare the basic treatment to communication treatments with promises by the buyers or threats by the seller.

They found that communication did in fact mitigate the hold-up problem. An important companion to Ellingsen and Johannesson a is Ellingsen and Johannesson b. A key difference between these two studies is that bargaining in the latter is not in ultimatum format. In that design, each of the two agents makes a claim.

The revenue is equal to 0 if the sum of the claims exceeds If the sum of the claims is or less, each subject gets his claim i. Other than that, the experimental designs are largely identical. Ellingsen and Johannesson a find that communication mitigates the hold-up problem.

Specifically, unilateral communication—by buyer or seller—facilitates coordination and increases investment. Hoppe and Schmitz study the effect of contracting on the hold-up game. They find that option contracts improve performance. Unlike Dufwenberg, they add a participation decision in which either party can decide to decline participating in the game.

After that stage, the game has the same structure as Dufwenberg et al. The buyer then learns the investment decision and makes a take-it-or-leave-it price offer. The seller can then take it or leave it. If he leaves it, he forgoes the cost of the investment—thus the hold-up. Hoppe and Schmitz model all contract decisions as eliminating one of the stages and thus reducing the hold-up problem to an investment problem. If he pays, he has to trust the seller to make the investment and not to expropriate the surplus.

In the option contract, the seller invests without the option of accepting or rejecting. They also investigated a contract with renegotiation which is similar in spirit to the communication study of Ellingsen and Johannesson a described above. Davis and Leider , similar to Hoppe and Schmitz , study the possibility that an option contract mitigates the holdup problem.

In the option contract, the retailer and supplier agree ex ante to buy and sell units up to D units at a wholesale price of w and the retailer pays a lump sum option fee to the supplier. The framework is different in that the first mover makes a capacity investment, demand is random, and bargaining is structured.

Bargaining is such that both roles have the ability to make multiple back-and-forth offers while also providing feedback on the offers they receive. They find that the option contract does indeed mitigate the hold-up problem.

There are other studies that model settings that are closer to the theoretical hold-up problem, without invoking the term. In Hackett experiment, for example, two players decide on respective investments that increase joint surplus but also increase individual cost. They then realize a probabilistic outcome that depends on the investments and then bargain over the joint surplus, with either party having a veto power.

Hackett finds that the surplus division is responsive to the investments. The setting is closer to the theoretical literature in that the unknown realization of the eventual outcome makes the contract incomplete—unlike the settings of Dufwenberg et al. The key innovation in the setting we study, that distinguishes it from the literature we summarized above, is the presence of asymmetric information.

So the asymmetric information aspect in our study is important for practice, and new in terms of research focus. It has been shown in experimental economics, as well as in the behavioral operation management literature, that people are not motivated exclusively by monetary payoffs—they have social preferences see Cooper and Kagel ; Loch and Wu ; Katok and Pavlov A stream of theoretical works investigates social preferences, such as inequality aversion, in the context of the hold-up problem Gantner et al.

Dufwenberg et al. We use a behavioral model to analyze the hold-up problem, but our behavioral model uses inequality aversion Bolton and Ockenfels ; Fehr and Schmidt ; Cui et al. We further solve the problem in a dynamic framework, whereas Dufwenberg et al. We analyze the dynamics by approximating a dynamic setting in our experiments and refer to this as dynamic approximation. Thus, our solution concept involves a tradeoff.

On the one hand, it is quite broad, which allows us to use it for testing a model that does not rely on reciprocity preferences and generalizing the solution to dynamic environments. On the other hand, our approach involves an approximation that captures how people think about the uncertain future actions of others.

We think this approximation is reasonable and is a good first step to understanding behavior in repeated settings. Our second behavioral contribution is a demonstration that reputation information can help solve the hold-up problem.

Reputation may serve in lieu of informal agreements Hart et al. Board shows that theoretically, even in the presence of many potential partners, an optimal contract design implies loyalty to existing partners. Footnote 1 Bolton et al.

They also report that, contrary to standard theory, some cooperation exists even without a formal feedback mechanism. Our work complements these earlier findings by showing that some cooperation is consistent with the dynamic equilibrium approximation in a repeated setting with a finite number of players. More importantly, we show that even though the dynamic approximation analysis is only an approximation for the actual setting in our experiment, it predicts the outcomes remarkably well.

In this section, we describe the basic game setting used in our study. We show that if players are motivated exclusively by monetary payoffs, the hold-up problem is severe. We then proceed to extend the model to include social preferences and random errors, and develop the dynamic equilibrium approximation that can predict that these behavioral considerations may mitigate the hold-up problem.

We begin with the basic setting, which is a sequential game with asymmetric information. The standard analysis assumes that players care exclusively about their monetary payoffs. We then proceed to add social preferences and random errors. The seller moves first and decides whether to produce or not produce. Quality is privately known to the buyer.

Footnote 2 That is, the seller does not know the quality while the buyer does. In the context of the buyer being an end consumer, this is a straightforward assumption. The end consumer knows whether he likes the product and finds it esthetically pleasing, functional, fitting, or satisfying. The seller does his best to satisfy the consumer but if the consumer claims to be dissatisfied the seller cannot verify whether this claim is correct. In a supply chain context, this motivation extends to downstream channel members.

The closer a channel member is to the end consumer, the more knowledge he has regarding end customer satisfaction, customer returns, malfunctions, customer service calls, warranty claims, customer reviews, customer churn, etc. Thus, the buyer possesses information about quality that the seller does not. Note that the innovation in our game is the presence of incomplete information: the buyer learns the product quality, and the seller does not.

Knowing this implies that in a single-shot game, the buyer has a dominant strategy to offer low price regardless of quality. We summarize the analysis of a single-shot game with profit-maximizing players as Proposition 1. The hold-up problem when conditions 1 — 2 are satisfied, the game is single shot, and players care exclusively about their monetary payoffs, the buyer will never offer a high price and the seller will never produce.

Sellers will not reject a low price due to condition 1. Buyers will not offer a high price in the single-shot game when they are motivated solely by monetary payoffs. Offering a low price in this setting is a dominant strategy. Sellers will not produce due to condition 2. We will apply to the game in Fig. Cui and Mallucci experimentally evaluated an environment structured similarly to ours in that there is a two-stage dyadic channel, in which firms decide on investments in the first stage and then on prices in the second stage.

Their utility specification is identical to our utility Eq. Specifically, the seller does not know quality realization but can form a belief about quality conditional on the price he was offered. The critical piece of information that the seller would like to know when he is offered a low price is whether this was due to low quality or not.

This gives us. We assume that the seller operates in the environment of being subject to disadvantageous inequality only. Consider the terms in Eq. These terms represent potential loss in utility to the seller due to being relatively worse off than the buyer. If it is also the case that. We call 4 the impunity condition. Therefore, this seller may reject a low price.

It has been shown that laboratory participants make random errors Su It is useful to incorporate these random errors into the analysis to obtain better estimates of behavioral parameters. We follow the basic idea of a logistic mapping between expected utilities and action probabilities e.

It implies that people are more likely to choose an action that yields higher expected utility. Our goal here is to construct a parsimonious model that captures the essential aspects of the problem setting.

The critical aspects of the problem setting are the ones that result in the hold-up problems: 1 the seller is financially better off to not produce unless there is a sufficient likelihood that the buyer will offer high price for high quality, and 2 in the long run, the buyer is much better off if the seller produces, even if he has to induce production by sometimes paying high prices for high quality. So the buyer and the seller face fundamentally different problems.

The seller will only produce if he expects to see a high price with sufficiently high probability. In contrast, the buyer is facing a clear tradeoff each period between the immediate payoff from paying low price for high quality and the loss from lack of production by suppliers in future rounds.

Footnote 3 That is, sellers need to form beliefs given the history of the game, whereas buyers need to develop reputations individually or as a group to make it desirable for sellers to produce. This framework results in simple theoretical benchmarks that capture most of the regularities of the data in our laboratory experiments.

Footnote 4. In this case, let the average probability of high price that sellers observe be. In the dynamic equilibrium approximation, sellers use 9 in 5 — 7 when they make their production and acceptance decisions. The buyer solves 8 to find her average equilibrium probability of offering high price for high quality.

Moreover, reputation information increases its value. We designed a laboratory setting in which the hold-up problem would be present in the single-shot game consistent with Proposition 1. Our experimental treatments vary in the effects seller rejection have on the profit of the buyer.

See appendix for experimental instructions. The experiment includes three treatments. In all treatments, we randomly assign participants to buyer and seller roles when they arrive at the laboratory, and they keep the roles for the duration of the session. Each treatment includes four sessions, and each session includes four buyers and four sellers.

Participants play the game corresponding to one treatment with payoffs corresponding to Fig. They are randomly re-matched each round. In total, our experiment includes 96 participants. We recruited participants using ORSEE recruitment system Greiner and offered cash as the only incentive to participate. We designed experimental software using zTree Fischbacher Our design examines the effect of social preferences by comparing impunity and reciprocity conditions.

Additionally, we test an intervention that we call reputation, in which we keep track and show to the seller the average number of times the current buyer offered a high price. In summary, our experiment includes the following three treatments:. In the impunity treatment, participants have access to their own prior history that includes past production decisions, the price offered if production occurred , and their own realized profits.

The buyers have one additional piece of information that sellers do not have—the realized quality for the current and all past periods. Participants have access to the same historical information as in the impunity treatment. In the reputation treatment, the payoffs are the same as in the impunity condition.

Historical information is different. Specifically, sellers see the proportion of the time the buyer with whom the seller is matched during the current period offered a high price; this buyer-specific history is shown to the seller prior to making the production decision. In the impunity treatment, a buyer motivated exclusively by monetary payoff derives his average equilibrium probability of offering high price for high quality according to Eqs.

Buyer expected profit as a function of the probability of offering high price for high quality in the impunity treatment. For a seller concerned with inequality aversion, this threshold would be higher. Hypothesis 1. In the impunity treatment, buyers offer high prices for high quality on average at least Sellers never reject any price offer. The utility from not producing is 2, while the expected utility from producing is. In the reciprocity treatment, rejection is not a dominated action for a seller because even though the seller foregoes 0.

This gives buyers an additional incentive to offer a high price for high quality in the reciprocity treatment. We summarize predictions about the differences between the impunity and reciprocity treatments in the following hypothesis:. Hypothesis 2. In the reciprocity treatment, the frequency of rejections of low prices will be higher than in the impunity treatment, the frequency of high prices for high quality will be higher than in the impunity treatment, and the production rate will be higher than in the impunity treatment.

Therefore, we expect higher proportion of high prices offered for high quality in the reputation treatment than in the impunity treatment, and indeed we can see from comparing Figs. Hypothesis 3 In the reputation treatment, production and high prices for high quality will be higher than in the impunity treatment.

Rejections will be similar across the two treatments. We present summary statistics for production, prices, profits and rejections in the three treatments. We then report estimates for a behavioral model that includes non-monetary preferences and errors. We report standard errors in parenthesis, and we use the session average as a unit of analysis recall that each treatment includes four sessions. All p values reported are for a t test with four independent session-level observations.

We examine the results as they relate to H1 pertaining to the impunity treatment. In fact, the proportion of high prices for high quality is not significantly different from the hypothesized 0. These aspects of the data are consistent with H1. However, two aspects of the data are not entirely consistent with the theory.

However, both are sufficiently small in absolute terms to be attributed to errors as we will show in the model estimation. We now turn our attention to H2, concerned with the comparison of the impunity and reciprocity treatments. H3 is concerned with the comparison of the impunity and reputation treatments.

We find the patterns in the data to be consistent with H3. In Fig. To focus on the trend, we aggregate periods of data into 20 five-period blocks. Rejections and production are highly stable after an initial learning that takes about 20 periods. The proportion of high prices for high quality is quite stable in rounds 21—80, but in the reputation treatment, in contrast to the reciprocity treatment, it exhibits end-game effect in the last 20 rounds.

This is not surprising; other studies also found end-game effects in reputation treatments see for example Bolton et al. In the next section, we report on estimation of a behavioral model using periods 21— for the analysis to eliminate the initial periods of steep learning. We estimate behavioral parameters for sellers only. Because the two decisions are not independent, we estimate them jointly through a joint likelihood function.

We assume that in the impunity and the reciprocity treatments, these forecasts are simply the average probability that seller j observed high prices in the past, multiplied by the unconditional probability of high quality. Note that subscript i does not appear on the right hand side because the seller cannot distinguish among different buyers in the impunity and the reciprocity treatments. We stress that even though the dynamic equilibrium approximation model in Sect.

An often quoted but also sharply disputed historic example concerned the US car industry. Fisher Body had an exclusive contract to supply body parts for the cars of General Motors. They were the only ones who could deliver the parts according to the specifications needed by GM. In the s there was a sharp increase in demand that exceeded all expectations that were held at the time when the contract was written.

It is claimed that Fisher Body used this unforeseen development to hold up General Motors, amongst others, by increasing the price for the additional parts produced. In a first stage, the Buyer makes a relationship-specific investment i.

Then due to the unforeseen increased demand , the Supplier has the opportunity to raise the price for the additional demand. In case the price is raised, the Buyer can, at their loss, change the Supplier. We run two treatments of this game which differ only by one parameter. More details, and a hand run version, are discussed in Balkenborg, Kaplan and Miller, a, b. In both treatments it is optimal for the Supplier to hold up the Buyer and for the Buyer to accept the hold-up.

In the first treatment it is optimal to invest even if there is a hold-up while in the second treatment it is better not to invest due to the hold-up. We choose this set-up because it allows students first to learn that there will be a hold-up and then to experience the economic consequence of underinvestment caused by the hold-up problem. We tend to run 8—10 rounds of each treatment with a different random pairing for each round. An even number of players is needed.

If no investment is made, both players get zero. The investment costs and the gross value produced is In the initial contract all surplus goes to the Buyer and they get while the Supplier makes zero profit. The Supplier can hold up the Buyer by raising their price by and leaving the Buyer with The Buyer could change the Supplier, but this hurts everybody.

The Buyer loses their investment and the Supplier loses all their business with the Buyer. Once the number of players is determined, we can complete the set-up of the experiment and give the students the access code to log in to the experiment via our website.

They are then assigned the roles of Buyers and Suppliers and can work through the computerised instructions. In each period the program randomly matches Buyers and Suppliers. In the following screenshot the Supplier is asked to keep or raise their price. The design of the screen is very simple to keep the emphasis on the basic decision. Typically subjects learn quickly to play the backward induction equilibrium.

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