Completely relationship-specific investments, transaction costs, and the property rights theory

In the property rights approach to the theory of the firm, ownership matters if parties have to make partly relationship-specific investments, but ownership would be irrelevant if the investments were completely relationship-specific. We show that if negotiations after the investment stage require transaction costs to be paid, then ownership matters even when investments are completely relationship-specific. While in the standard model without transaction costs there are underinvest-ments compared to the first-best benchmark, in our setting a party may overinvest in order to induce the other party to incur the transaction costs that are necessary to enter the negotiation stage.(c) 2023 The Author(s). Published by Elsevier B.V. This is an open access article under the CC BY-NC-NDlicense (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Automated summary

In the property rights approach to the theory of the firm, ownership matters when parties have to make relationship-specific investments, but it remains important even when the investments are completely relationship-specific if negotiations after the investment stage require transaction costs. In this setting, a party may overinvest to induce the other party to incur the necessary transaction costs for entering the negotiation stage, leading to different investment outcomes compared to the standard model without transaction costs.