Hold-Up Problem: Underinvestment in Parts Transactions
The aim of this case material is (not to study the accounting or personnel aspects but) to clarify some points in the hold-up problem which arises as a major issue in incomplete contracts. We consider a simplified situation based on the merger of Fisher body (body supplier) by GM (automaker). It is difficult to codify every possible contingency in contracts, and thus ambiguous arrangements will remain in the statements about the terms and conditions of transactions. This incompleteness of contracts may cause manufacturer's or supplier's underinvestment in relation-specific equipments or skills in parts transactions. How can we resolve this problem? If it is difficult to resolve it, what should we keep in mind for our management decision? Readers can understand the contents of this case material more easily, if they have knowledge of the differentiation of quadratic functions. The Appendix classifies transaction costs from two different aspects.