Revenue sharing agreements and hold-up problems in joint projects: Theory and experiments

Abstract

The lack of property rights in joint projects can cause hold-up problems, as expected fights over the proceeds make investing not worthwhile. We investigate theoretically and experimentally if the availability of different contractual sharing rules can solve the hold-up problem. As theory predicts, we find that the availability of first-best contracts that divide revenue proportional to investment shares yields high uptake, extensive investment and high efficiency. First-best sharing contracts are often not feasible. Simple equal-split contracts are a prominent but theoretically ineffective alternative. Contrary to theoretical predictions, making cheap equal-split contracts available is welfare increasing. Cooperative participants opt for the contract with the correct expectation that despite the lack of incentives significant investment will follow. This leads to welfare gains. The better than expected performance of equal-split contracts provides a rationale for their frequent use in the field.