Bargaining under Incomplete Information, Fairness, and the Hold-Up Problem

In the hold-up problem incomplete contracts cause the proceeds of
relation specific investments to be allocated by ex-post
bargaining. The present paper investigates the efficiency of
incomplete contracts if individuals have heterogeneous preferences
implying heterogeneous bargaining behavior and - equally important
- preferences are private information. As the sunk investment costs
can thus potentially signal preferences, they can influence beliefs
and consequently bargaining outcomes. The necessities of signalling
are shown to generate very strong investment incentives. These
incentives are based on the desire not to reveal information that
is unfavorable in the ensuing bargaining. After finding all perfect
Bayesian equilibria in pure strategies, the paper derives the
necessary and sufficient conditions under which it is optimal to
invest and trade efficiently.