Strategic Shirking in Bilateral Trade by

Summary This paper explores a version of the canonical holdup model where agents undertake specific investments prior to their transaction. In this setting, we identify a novel reason for contractual inefficiency. An investing party (here, the seller) may shirk for strategic reasons, in particular, exert an effort so low that subsequent trade becomes inefficient. We first show that under a fixed-price contract which would otherwise be optimal and induce trade, strategic shirking can arise irrespective of the precontracted trade price. We then establish that if strategic shirking arises under a fixed-price contract, no general mechanism exists which restores efficient trade. Finally, we show that the defection issue is more severe when the parties trade after the buyer’s valuation was realized, as compared to a scenario where the trade transaction is finalized in a state of uncertainty