Previous analysis has shown that traders may opt for specific technologies with no
joint productivity advantage as a way to commit themselves to trading jointly, but
only when long-term contracting is infeasible. This paper proves that speciÞcity can
also be optimal (by relaxing the budget-balance constraint) in settings with long-term
contracting. Traders will opt for specificity when one trader makes a cross-investment
and either (1) this cross-investment has a direct externality on the other trader, ...
Previous analysis has shown that traders may opt for specific technologies with no
joint productivity advantage as a way to commit themselves to trading jointly, but
only when long-term contracting is infeasible. This paper proves that speciÞcity can
also be optimal (by relaxing the budget-balance constraint) in settings with long-term
contracting. Traders will opt for specificity when one trader makes a cross-investment
and either (1) this cross-investment has a direct externality on the other trader, (2) both
parties invest, or (3) private information is present. The specificity (e.g. from non-
salvageable investments, specific assets and technologies, narrow business strategies,
and exclusivity restrictions) is equally effective regardless of which trader's alternative
trade payoff is reduced. Specificity supports long-term contracts in a broad range
of settings - both with and without renegotiation. The theory also offers a novel
perspective on franchising and vertical integration.
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