Mahmet Bac

"To invest or screen efficiently: a potential conflict in relationships governed by incomplete contracts"

JEL codes: L14; J41
Keywords: Incomplete contracts; screening; relationship-specific investments; Bayesian equilibrium

Abstract:   We consider a dynamic trade relationship where quality is not contractible and potential sellers retain quality-relevant private information. We show that the presence of an investment technology to improve the incumbent sellerīs innate quality may impair the efficiency of the screening process. If the conflict is effective, the buyer has to induce an inefficient screening process or reduce the productivity of the investment technology. This conflict suggests that the hold-up problem may be more severe than predicted by models of incomplete contracts that assume complete information