Can a contract solve hold-up when investments have externalities? A comment on De Fraja (1999)

This comment finds an error in De Fraja (1999), the correction of which ove rturns its main result. In contrast to his claim, under a mild condition, t he suggested contract is not only unable to solve the hold-up problem but i t can provide almost no incentive for specific investments, when they exhib it sufficiently large direct externalities. His result holds primarily when the investments have no externalities. We remark on a related result in th e literature and propose an alternative contract that achieves efficiency. Journal of Economic Literature Classification Numbers: C70, J41, K12, L22. (C) 2000 Academic Press.