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Wickelgren, Abraham L. --- "Option Contracts and the Holdup Problem" [2011] ELECD 130; in De Geest, Gerrit (ed), "Contract Law and Economics" (Edward Elgar Publishing, 2011)

Book Title: Contract Law and Economics

Editor(s): De Geest, Gerrit

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781847206008

Section: Chapter 13

Section Title: Option Contracts and the Holdup Problem

Author(s): Wickelgren, Abraham L.

Number of pages: 17

Extract:

13 Option contracts and the holdup
problem*
Abraham L. Wickelgren


1. Introduction
Any contract that is enforced through money damages, as opposed to
specific performance, is, in some sense, an option contract. The perform-
ing party has the option to perform or pay damages. That said, contracts
are normally only referred to as option contracts if it `is a promise which
meets the requirements for the formation of a contract and limits the
promisor's power to revoke an offer' (Restatement (Second) of Contracts
Section 25). Economic analysis of option contracts has been recent, and
it has almost exclusively focused on the efficacy of option contracts as a
solution to the holdup problem.1 While, as Katz (2004) has noted, both the
optimal design of option contracts and the special doctrinal treatment of
option contracts are worthy of detailed analysis, this chapter will follow
the existing literature and focus on the conditions under which option con-
tracts provide a robust solution to the holdup problem. In reviewing this
literature, the chapter will find that the details of the model, and in par-
ticular, the bargaining process, are critical in determining whether or not
the holdup problem is a significant and inevitable feature in a non-trivial
number of contractual situations.
The next section of this chapter describes the holdup problem in detail
and discusses its importance to creating a coherent theory of firm bounda-
ries. It also introduces the mechanism by which option contracts might
provide a contractual solution to ...