The dynamics of productive assets, contract duration and holdup

Abstract

The owner of an asset often transfers the right to use or exploit that asset to an agent in exchange for a rent. A limited time of the license and the failure of the owner's commitment to compensate the agent for any asset improvement are likely to lead to underinvestment (holdup). In this study, we analyze the optimal length a contract would need to have to maximize the owner's income in the short- and long-run. We determine the design of a sequence of renegotiation-proof, overlapping, fixed time contracts that allows eliminating the hold-up problem. The obtained outcomes are tested and illustrated on a specific problem (land lease and soil quality). Numeric simulation demonstrates that the most severe version of the hold-up problem arises when the lease contract is not long enough for farmers to make any investment in the soil quality (less than 3 years on calibrated data)