Holdup and the Evolution of Bargaining Conventions

As Posner (1997) has observed, when individuals in a relationship can commit to imposing costs upon each other then efficient behavior in the absence of law is possible. The question is whether efficient norms of behavior evolve endogenously in a population. We show that in a standard hold up model in which both parties make relationship specific investments that the long run outcome of a stochastic adaptation process similar to Young's (1993) 'adaptive play' does in general not correspond to the efficient equilibria. As Grossman and Hart (1986) observe, institutions, such as firms, may be needed to improve the allocation of resources.