Hold-up problem
Encyclopedia
In economics
, the hold-up problem is a situation where two parties (such as a supplier and a manufacturer or the owner of capital and workers) may be able to work most efficiently by cooperating, but refrain from doing so due to concerns that they may give the other party increased bargaining power
, and thereby reduce their own profits. It has been described as the "most influential work" in recent decades on why firms exist and what determines their boundaries.
For example: Imagine a scenario where profit can be made if agents X and Y work together, so they form an agreement to do so, after X buys the necessary equipment. The hold-up problem occurs when X might not be willing to accept that agreement, even though the outcome would be Pareto efficient, because after X buys the necessary equipment, Y would have bargaining power and might decide to demand a larger proportion of the profits than before. The source of Y's power lies in X's investment. Since X is now deeply invested in the project, but Y is not, X stands to lose money, should the deal not be completed, but Y has no such risk. Thus, Y has some bargaining power that did not exist before X's investment. In the extreme, Y could demand 100% of the profits, if X's only alternative is to lose the initial investment entirely.
One way to avoid the hold-up problem is for the firms to merge, a tactic known as vertical integration
, or to enter vertical agreement
s, e.g. an agreement with a non-compete clause
.
A hold-up problem inherent in binary software
transactions has been proposed as one of the reasons for the success of open source software
.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, the hold-up problem is a situation where two parties (such as a supplier and a manufacturer or the owner of capital and workers) may be able to work most efficiently by cooperating, but refrain from doing so due to concerns that they may give the other party increased bargaining power
Bargaining power
Bargaining power is a concept related to the relative abilities of parties in a situation to exert influence over each other. If both parties are on an equal footing in a debate, then they will have equal bargaining power, such as in a perfectly competitive market, or between an evenly matched...
, and thereby reduce their own profits. It has been described as the "most influential work" in recent decades on why firms exist and what determines their boundaries.
For example: Imagine a scenario where profit can be made if agents X and Y work together, so they form an agreement to do so, after X buys the necessary equipment. The hold-up problem occurs when X might not be willing to accept that agreement, even though the outcome would be Pareto efficient, because after X buys the necessary equipment, Y would have bargaining power and might decide to demand a larger proportion of the profits than before. The source of Y's power lies in X's investment. Since X is now deeply invested in the project, but Y is not, X stands to lose money, should the deal not be completed, but Y has no such risk. Thus, Y has some bargaining power that did not exist before X's investment. In the extreme, Y could demand 100% of the profits, if X's only alternative is to lose the initial investment entirely.
One way to avoid the hold-up problem is for the firms to merge, a tactic known as vertical integration
Vertical integration
In microeconomics and management, the term vertical integration describes a style of management control. Vertically integrated companies in a supply chain are united through a common owner. Usually each member of the supply chain produces a different product or service, and the products combine to...
, or to enter vertical agreement
Vertical agreement
A vertical agreement is a term used in competition law to denote agreements between firms at different levels of the supply chain. For instance, a manufacturer of consumer electronics might have a vertical agreement with a retailer according to which the latter would promote their products in...
s, e.g. an agreement with a non-compete clause
Non-compete clause
A non-compete clause , or covenant not to compete , is a term used in contract law under which one party agrees not to pursue a similar profession or trade in competition against another party . As a contract provision, a CNC is bound by traditional contract requirements including the...
.
A hold-up problem inherent in binary software
Machine code
Machine code or machine language is a system of impartible instructions executed directly by a computer's central processing unit. Each instruction performs a very specific task, typically either an operation on a unit of data Machine code or machine language is a system of impartible instructions...
transactions has been proposed as one of the reasons for the success of open source software
Open source
The term open source describes practices in production and development that promote access to the end product's source materials. Some consider open source a philosophy, others consider it a pragmatic methodology...
.