Why Sunk Costs Matter for Bargaining Outcomes: An Evolutionary Approach

Economics

Further details

Two bargaining parties play the Nash Demand Game to share a pie whose size is determined by one party's investment decision. Various investment levels are subgame-perfect. Adding the investment decision to Young's evolutionary bargaining model yields the following long-run outcome: efficientinvestment prevails and the investor's share of the pie approximates the maximum of (i) the smallest share that induces efficient investment, even if the investor expects to appropriate the available pie from every inefficient investment, and (ii) half of the pie. The result favors forward induction to subgame consistency and equity theory to hold-ups.