Abstract:

We analyze noncontractible investments in a model with shading. A seller can make an
investment that affects a buyer’s value. The parties have outside options that depend on asset
ownership. When shading is not possible and there is no contract renegotiation, an optimum can
be achieved by giving the seller the right to make a take‐it‐or‐leave‐it offer. However, with
shading, such a contract creates deadweight losses. We show that an optimal contract will limit
the seller’s offers, and possibly create ex post inefficiency. Asset ownership can improve matters
even if revelation mechanisms are allowed.

Games - Link to paper.