Thus, once the investment has been sunk, it generates quasi-rents—amounts in excess of the return necessary to keep the invested assets in their current use. There could, but need not be pure rents— returns in excess of those needed to cause the investment to be made in the first place.
The terms ex ante and ex post—"before the fact" and "after the fact"—are widely used in this literature. In the hold-up story, the investment must be made ex ante, before a binding agreement is reached, while the renegotiation is ex post, after the investment. More generally, the literature refers to negotiations that occur after some irreversible act, including the establishing of the relationship, as ex post bargaining.
Whinston (1997) takes a close look at the empirical distinctions of transactions cost theory and property rights theory.
This is changing. Recently, for example, influence cost ideas (Milgrom and Roberts 1988, 1990, Meyer, Milgrom, and Roberts 1992) have been used to explain observed inefficiencies in internal capital markets (Scharfstein 1998, Shin and Stulz 1998).
Hart and Moore (1990) and many others have developed the property rights approach further. See Hart (1995). Recent additions include DeMeza and Lockwood (1998) and Rajan and Zingales (1998). Holmstr m (1996) offers a critical commentary.
If the parties can contract on the investments, the assumption of efficient bargaining means that they will be made at the efficient levels, irrespective of ownership patterns.
Supermodularity of a function means that an increase in one argument increases the incremental return from all the other arguments. With differentiable functions, the cross-partials are all non-negative. In the Hart-Moore model, supermodularity refers both to human capital and to assets, so that having more assets implies a higher marginal return to all investments. See Milgrom and Roberts (1994).
Holmstr m and Milgrom (1994) and Holmstr m (1996) argue that the function of firms cannot be properly understood without considering additional incentive instruments that can serve as substitutes for outright ownership. Employees, for instance, typically own no assets, yet they often do work quite effectively. In these theories asset ownership gives access to many incentive instruments and the role of the firm is to coordinate the use of all of them. That may also explain why non-investing parties, including the firm itself, own assets.
This pattern, however, did not become standard until decades after the founding of the industry. Earlier, something akin to the practices associated now with the Japanese was the norm. See Helper (1991).
An alternative story is more in the line of Williamson's earlier discussions emphasizing inefficiencies in ex post bargaining. The useful life of a die far exceeds the one-year contracting period. If the supplier owned the die, changing suppliers would require negotiating the sale of the die to the new supplier, and this could be costly and inefficient.
Interestingly, Toyota followed U.S. practice in supplying the dies used by at least some of the suppliers to its Kentucky assembly plant (Milgrom and Roberts 1993).
Taylor and Wiggins (1997) argue that these long-term relations are also the means used in the Japanese system to solve moral hazard problems with respect to quality.
Baker et al. (1997) present a formal analysis of the choice between external and internal procurement, taking into account the important fact that long-term relational contracts can be maintained both within a firm as well as across firms.
Strikingly, as automobile electronics have become more sophisticated and a greater part of the cost of a car, Toyota has ceased to rely exclusively on its former sole supplier, Denso, and has developed its own in-house capabilities in this area. Arguably, this was to overcome information asymmetries and their associated costs (Ahmadjian and Lincoln 1997). In contrast, see the discussion of the effects of Ford's complete reliance on Lear for developing seats for the redesigned 1997 Taurus (Walton 1997).
See Segal and Whinston, 1997, for a model in the property rights spirit that is relevant to these issues.
For a further discussion of the idea that low-powered incentives are a major virtue of firm organization and can help explain firm boundaries, see Holmstr m (1996).
See Lutz (1995) for a formal model of franchising along these lines.
A hold-up story is consistent with the fact that the presence of repair services favors dealer ownership over leasing arrangements in the U.S. data: A lessee who invests in building a clientele for repair work might worry that the refining company will raise the lease payments to appropriate the returns from this investment. This argument, however, does not do much to explain the pattern in the Canadian data, where the refiners own all the stations. One might also attempt to apply this logic to the choice between company-owned and leased stations by arguing that if the company owns the station it cannot motivate the employee-manager to invest in building a clientele because it will appropriate all the returns. However, this argument is not compelling without explaining how firms in other industries succeed in motivating their employees to undertake similar investments.
See Aghion and Tirole (1997) for a model along these lines. In general, the role of firm boundaries in limiting interventions by more senior managers, thereby improving subordinates' incentives in various ways, has been a basic theme in the influence cost literature (Milgrom and Roberts 1990, Meyer et al. 1992).
In contrast, researchers outside economic theory have made much of the role of knowledge. See, for instance, Teece et al. (1994).
Stuckey (1983), in his extraordinary study of the aluminum industry, reports that knowledge transfer was an important driver of joint ventures.
See Halonen (1994) for a first modeling effort along these lines.