Does making specific investments unobservable boost investment incentives?

Published in: Journal of Economics and Management Strategy 16 (2007). 911-942. (with Randolph Sloof and Joep Sonnemans)

Economic theory predicts that holdup may be alleviated by makingrnspecific investments unobservable to the non-investor. Private informationrncreates an informational rent that boosts investment incentives.rnExperimental findings, however, indicate that holdup is attenuatedrnby fairness and reciprocity considerations. Private informationrnmay interfere with this, as it becomes impossible to directly observernwhether the investor behaved fair or not. In that way unobservabilityrncould crowd out the fairness/reciprocity mechanism. This paperrnreports on an experiment to investigate this issue empirically. Ourrnresults are in line with standard theoretical predictions when there isrnlimited scope for fairness and reciprocity. But with sufficient scopernfor these motivational factors, unobservability does not boost specificrninvestments.

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