2008. The importance of hold up in contracting: Evidence from a fi eld experiment. Working Paper

Abstract

This paper explores how the relationship specificity of an investment affects the ex-ante structure of contracts and the ex-post resolution of an ensuing hold-up problem. We set up a field experiment in the wholesale market for pens in India where we sent trained auditors as entrepreneurs to procure large orders of pens from wholesale dealers. We vary the specificity of the order by either buying generic or custom-printed lots of pens. We find clear support for the importance of incomplete contracting models. The greater threat of hold-up in the case of printed pens leads wholesalers to demand a significantly higher upfront payment compared to generic pens. Similarly, when faced with actual hold-up, wholesalers are more willing ex-post to renegotiate an order and accept lower prices in the case of printed pens. But while the signs of the contract terms corroborate the intuitions of incomplete contracting models, they do not explain the magnitudes we observe. First, the level of the upfront payment is so low that it is does not cover the procurement costs of the wholesaler. And second, we find that wholesalers often do not use their bargaining power even when a shopper holds them up ex-post. In fact we observe that in 60 % of the generic deals they return the upfront payment when the shopper tries to hold them up. We also find that there is a lot of variation in the contract structure that is not explained by the relationship specificity of the investment