Does Making Specific Investments Unobservable Boost Investment Incentives ?

Abstract

Standard theory predicts that holdup can be alleviated by making specific investments unobservable; private information creates an informational rent that boosts investment incentives. Empirical findings, however, indicate that holdup is attenuated by fairness and reciprocity motivations. Private information may interfere with these, as it becomes impossible to observe whether the investor behaved fair or not. In that way unobservability could crowd out an informal fairness/reciprocity mechanism in place. This paper reports on an experiment to investigate this issue empirically. Our results are in line with standard predictions when there is limited scope for social preferences. But with sufficient scope for these motivational factors, unobservability does not boost specific investments.

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