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The Effect of Power Imbalances on Incentives to Make Non-Contractible Investments

Marco Faravelli and Oliver Kirchkamp and Helmut Rainer

We use an experiment to study the effect of ex-post sharing rules on relationship-specific investments in an incomplete contracting context. We find that no power structure can induce first-best investments and that equally productive partners reach more efficient outcomes with a balanced power structure (i.e., equal sharing of returns) than with an asymmetric one. In addition, we find evidence for behavioural effects: partners make higher investments and reach higher efficiency levels than own-payoff maximisation would suggest. This behaviour is in line with a model where decision-makers care about social efficiency. It is not consistent with inequality-averse preferences.

JEL-Classification: C91, D23, D86

Keywords: Incomplete Contracts, Relationship-Specific Investment, Allocation of Power, Social Preferences, Experiments.