The effect of power imbalances on incentives to make non-contractible investments

•We study investments in a partnership with fixed profit sharing.•If players are selfish these investments are inefficiently low.•In a lab experiment investments are significantly higher than selfish investments.•Participants show concerns for social welfare, no inequality aversion, no competitive preferences.•Participants share power.

We use an experiment to study the effect of ex-post sharing rules on relationship-specific investments in an incomplete contracting context. We find that no power structure can induce first-best investments and that equally productive partners reach more efficient outcomes with a balanced power structure (i.e., equal sharing of returns) than with an asymmetric one. In addition, we find evidence for behavioural effects: partners make higher investments and reach higher efficiency levels than own-payoff maximisation would suggest. This behaviour is in line with a model where decision-makers care about social efficiency. It is not consistent with inequity-averse preferences.

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