Hold-up and the evolution of investment and bargaining norms

The purpose of this paper is to explore the evolution of bargaining norms in a simple production problem with two-sided relationship specific investments and competition. The puzzle we wish to address is why efficient bargaining norms do not evolve even though there exist efficient sequential equilibria. Conditions under which stochastically stable bargaining conventions exist are characterized, and it is shown that there is a hierarchy of norms, with a stochastically stable division rule that is independent of the long run investment strategy. Due to this independence, efficient sequential equilibria are not in general stochastically stable. This result may help us understand why institutions, such as firms, may be needed to ensure efficient relationship specific investments.