Post-Investment Holdup and Contracts: Exploring Scenarios

Scenario A

In Chapter 5 of Managerial Economics, Froeb discussed post-investment holdup as a sunk cost problem associated with contract-specific fixed investments. The modern theory of contracts is sometimes called the theory of joining wills, which simply means when parties make an agreement, they are joining together to complete an endeavor of mutual interest. The problem with all contracts that endure over time is that not all potential challenges can be anticipated. The idea of joining wills is that parties will attempt to seek accommodations to advance their mutual interest, so long as the return on the invested activity pays off. Froeb illustrates the idea by the example of marriage as a contract (1).

Sources

1.Luke M. Froeb. 2018. Managerial Economics: A Problem Solving Approach (5th ed.). p. 59. Cengage.

Review the three scenarios below. Look for which, if any, of these scenarios presents an example of post-investment holdup.

A.Your firm conducted a search for a new chief financial officer and hired a highly qualified candidate with a yearly salary of $250,000. After six months, the person left to join another firm.

B.Your firm has an exclusive contract to assemble automobile seats for a number of luxury models. Almost 100% of the materials are imported and, of those, over 50% include parts manufactured in China. All of the prices on the parts from China increased by 25% when the U.S. imposed tariffs on China. Your company has informed all of its customers that increased cost must be passed on for your firm to continue supplying the seats. All of your customers reluctantly agreed to pay the additional cost.

C.Your company took note of your progress toward your MBA, and when the director for customer services left the company, you were asked to take over as interim director. You were encouraged to apply for the full-time position once you got your MBA. You served for 13 months, at which time your company was acquired by another company and your position was abolished.

In your discussion post, address the following:

Answer the questions:

1.Which of the above, if any, are an example of post-investment holdup?

2.Define the following and explain each within the context of a chosen scenario:

a.What is the sunk, or stranded, cost?

b.What is the contract?

c.Was the contract breached?

d.What are the damages?