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Journal of Law, Economics, and Organization Advance Access originally published online on November 3, 2005
Journal of Law, Economics, and Organization 2006 22(1):234-257; doi:10.1093/jleo/ewj006
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© The Author 2005. Published by Oxford University Press on behalf of Yale University. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Specificity Revisited: The Role of Cross-Investments

Matthew Ellman

Universitat Pompeu Fabra

matthew.ellman{at}econ.upf.es

Previous analysis has shown that traders may opt for specific technologies with no joint productivity advantage as a way to commit themselves to trading jointly, but only when long-term contracting is infeasible. This paper proves that specificity can also be optimal (since it relaxes the budget balance constraint) in settings with long-term contracting. Traders will opt for specificity when one trader makes a cross-investment and either (1) this cross-investment has a direct externality on the other trader, (2) both parties invest or (3) private information is present. The specificity (e.g. from non-salvageable investments, specific assets and technologies, narrow business strategies, and exclusivity restrictions) is equally effective regardless of which trader's alternative trade payoff is reduced. Specificity supports long-term contracts in a broad range of settings - both with and without renegotiation. The theory also offers a novel perspective on franchising and vertical integration.


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