The importance of holdup in contracting: Evidence from a field experiment

This paper explores how the relationship specificity of the investment affects the ex-ante structure of contracts and the ex-post resolution of an ensuing holdup problem. We set up a field experiment in the wholesale market for pens in India where we sent entrepreneurs as auditors to procure large orders of pens from wholesale dealers. We vary the specificity of the order by buying either generic or custom-printed lots of pens. We find that ex ante contracts alleviate the risk of holdup by demanding 25% higher upfront payments on average in the case of custom-printed pens. But we do not find that wholesalers demand higher prices for custom-printed pens after controlling for the cost of the printing. We also test the ex post renegotiation of contracts. We find that wholesalers offer a higher price discount in case of custom-printed than generic pens. Furthermore, the higher the upfront payment, the lower is the discount offered by the wholesaler, which suggests that the wholesaler's bargaining power affects his willingness to renegotiate. Interestingly, in case of generic pens, we also find that wholesalers are often willing to refund the upfront paid. These findings confirm the predictions of Grossman and Hart (1986) or Hart and Moore (1990) on the importance of holdup costs in contracting. But in addition, there is large variation in contract structures which is not explained by specificity of investment and bargaining power based on outside options.