Incomplete Contracts and Investment: A Study of Land Tenancy in Pakistan

When contracts are incomplete, relationship specific investments may be under-provided due to the threat of opportunism or ‘holdup’. This paper finds evidence of a holdup problem in rural Pakistan. Land specific investment is lower on leased plots than on owned plots cultivated by the same household, even after correcting for the effects of adverse selection in the leasing market. Greater security of tenure is also found to increase investment on leased plots. Differences in tenure security appear to be largely driven by heterogeneity across landlords in their willingness to commit to long-term relationships, suggesting that some landlords value reputation more than others. These findings have implications for both land and tenancy reform