We propose a solution to the hold-up problem: the parties in a contract can
avoid the inefficiencies caused by the possibility of opportunistic behavi
our and implement the first best level of investment if they make their inv
estment decision sequentially, one party observing the choice made by the o
ther party before making his own choice. Unlike the existing literature, th
e proposed solution leads to the efficient choice of investment even when t
here are two-sided direct externalities. Classification Numbers: D23, D82.
(C) 1999 Academic Press.