Seminars

Abstract: The hold-up problem is one of the most fundamental and enduring issues in the field of Behavioral Industrial Organization. Although incomplete contracts have been studied extensively, the literature is lacking empirical, and especially experimental evidence. This paper examines the effects of fixed cancellation payment on the hold-up problem through parameterized modeling and results of a lab experiment. Our experiment results conform to the equilibrium prediction in general: setting the cancellation payment too low can lead to agents being held-up, resulting in inefficiently low investment; setting it sufficiently high can enhance the agent's incentive and solve the hold-up problem, but setting it too high could lead to the agent to invest an inefficiently high amount, i.e. the reverse hold-up problem. Our study has important policy implications that carefully designed cancellation clauses could be harnessed by policymakers and mechanism designers to achieve outcomes that maximize social welfare; Another takeaway from our experiment is the learning effect, which also implies that policymakers could expect a contract regime to become increasingly effective over time.