Third Parties and Specific Investments

Abstract

Competitive advantage is typically based on a unique nexus of firm-specific investments that creates inimitable quasi-rents. Because it is impossible to write complete contracts on how to distribute the quasi-rents, stakeholders tend to underinvest in firm-specific assets to avoid the hold-up risk. This paper empirically tests the effect of third-party ownership on specific investments. Third-party ownership assigns the rights of residual control to independent fiduciaries. We conduct variations of the trust game, in which a third party, rather than the receiver, distributes the returns on investments. A randomly chosen third party with a fixed payment induces larger investments over time although the experimental design rules out reputation building. If receivers select the third parties, this benefit vanishes. If the third party receives a reward for the appointment, investments actually decrease. Investors (unwarrantedly) fear lower back transfers in such cases.

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Notes

  1. 1.

    Another approach to protect firm-specific investments is to increase the decision rights and bargaining power of those who contribute to the quasi-rents. Such a shared ownership model recommends that firm-specific investors participate in all matters not specifically regulated via contracts or the law (Furubotn (1988); Blair (1995); Franck (2002); Osterloh and Frey (2006)). However, the involvement of many firm-specific investors with heterogeneous interests is likely to result in high costs of collective decision-making. For a detailed comparison of the shared ownership and third-party ownership model, we refer to Nüesch and Franck (2010).

  2. 2.

    Because we played 10 rounds but had only nine investors, receivers and third parties per session in RTP, STP and CTP, a perfect stranger matching protocol was not feasible. However, due to the investor’s lack of knowledge of the assigned receiver’s or third party’s identity, the large number of subjects, and the random matching protocol, repeated game effects should not play a role.

  3. 3.

    The experiments were conducted in German. The instructions in the Appendix A constitute a translation of the original instructions.

  4. 4.

    At the time of the experiment, 1 Euro equaled about 1.3 USD.

  5. 5.

    Fehr (2009) provides a summary of the relevant results in this context; Johnson and Mislin (2011) provide a meta-analysis.

  6. 6.

    Due to the heterogeneity of preferences among the different receivers we actually obtain multiple equilibria regarding the optimal proposal of a third party in this case. We assume that the proposing third parties can overcome the resulting coordination problem.

  7. 7.

    The results remain virtually the same whether we cluster the standard errors on the subject level or whether we estimate random effects models.

  8. 8.

    The exclusion of observations with 0 investments reduces the sample by 278 observations and by one subject who experienced 0 investments in all ten rounds.

  9. 9.

    The statistical tests are robust to the use of alternative tests like non-parametric Wilcoxon rank-sum tests.

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Correspondence to Stephan Nüesch.

Additional information

We are grateful to Björn Bartling, Urs Fischbacher, Christian Grund, Roberto Weber and seminar participants at the WK ORG Workshop 2015 in Zürich, at the Thurgau Institute of Economics, the University of Aachen (RWTH), the University of Freiburg, the University of Konstanz and the International Meeting on Experimental and Behavioral Economics (IMEBE) 2013 in Madrid for helpful comments. The usual disclaimer applies.

Appendices

Appendix A

General Instructions for the Participants in the Treatment BASE

This is an English translation of the German instructions of the baseline treatment BASE. We integrated control questions about the experiment into the z‑tree file.

We would like to welcome you to this economic experiment.

Your decisions and if applicable the decisions of the other participants in this experiment can influence your payment. It is important that you carefully read these instructions. If you have any questions, please ask before the experiment starts. All participants receive the same instructions.

During the experiment it is not allowed to talk with other participants. Disregard of this rule will lead to exclusion from the experiment and the payment.

During the experiment we do not talk about Euros. We talk about points instead. Your payment will be first calculated in points. The total number of points you will achieve in this experiment will be converted into Euros at the end with a conversion rate of:

$$1\text{point}=1\text{Euro}$$

We will pay out the payment in cash at the end of today’s experiment. On the following pages we explain the detailed procedure of this experiment.

Structure of the Experiment

In this experiment you are always a group of two. In this pairing there is always a participant A and a participant B. At the beginning of the experiment the computer randomly determines if you are a participant A or B. You will keep the same role during the whole experiment.

The experiment lasts for ten rounds. In each round a new pairing will be formed at random . We explain the procedure of one round. All ten rounds have the same procedure. You will be paid according to the points achieved in a randomly chosen round.

Participant A and participant B are endowed with 10 points. Participant A can send between 0 and 10 points to participant B. The amount sent is tripled by the experimenter and given to B. Participant B can now decide how many of the received points to return back to participant A. This back transfer is not tripled.

The participants will receive the following payment, if the computer determines this round for the payment:

  • Participant A: 10 points − amount sent by participant A + back transfer,

  • Participant B: 10 points + 3 × (amount sent by participant A)  − back transfer.

At the end of a round the participants will be informed about their points earned in that round.

Sequence of Decisions

A round proceeds on the screen as follows. Firstly, participant A decides on the transfer to B by entering a number between 0 and 10 and reports his belief about the expected back transfer. Parallel participant B reports his belief concerning the amount sent by participant A.

Participant B then learns how many points A has sent and how many points B accordingly has received. Then participant B decides on the back transfer by entering the corresponding amount.

General Instructions for the Participants in the Treatment RTP

This is an English translation of the German instructions of the treatment RTP. We integrated control questions about the experiment into the z‑tree file.

Structure of the Experiment

In this experiment you are always a group of three. In this triad there is always a participant A, a participant B and a participant C. At the beginning of the experiment the computer randomly determines if you are a participant A, B or C. You will keep the same role during the whole experiment.

The experiment lasts for ten rounds. In each round the triad will be newly formed at random. We explain the procedure of one round. All ten rounds have the same procedure. You will be paid according to the points achieved in a randomly chosen round.

Participant A and participant B are endowed with 10 points. Participant A can send between 0 and 10 points to participant B. The amount sent is tripled by the experimenter and given to B. Participant C can now decide how many of the received points to return back to participant A. This back transfer is not tripled. C cannot return more than B received from A. The 10 points that B received from the experimenter remain with B in any case. Participant C receives 10 points from the experimenter independent of her decision.

The participants will receive the following payment, if the computer determines this round for the payment:

  • Participant A: 10 points − amount sent by participant A + back transfer,

  • Participant B: 10 points + 3 × (amount sent by participant A)  − back transfer,

  • Participant C: 10 points.

At the end of a round the participants will be informed about their points earned in that round.

Sequence of Decisions

A round proceeds on the screen as follows. Firstly, participant A decides on the transfer to B by entering a number between 0 and 10 and reports his belief about the expected back transfer. Parallel participant B reports his belief concerning the amount sent by participant A.

Participant C then learns how many points A has sent and how many points B accordingly has received. Then C decides on the back transfer by entering the corresponding amount. Parallel participant B reports his belief concerning the amount sent by participant C.

General Instructions for the Participants in the Treatment STP

This is an English translation of the German instructions of treatment STP. We integrated control questions about the experiment into the z‑tree file.

Structure of the Experiment

In this experiment you are always a group of three. In this triad there is always a participant A, a participant B and a participant C. At the beginning of the experiment the computer randomly determines if you are a participant A, B or C. You will keep the same role during the whole experiment.

The experiment lasts for ten rounds. We explain the procedure of one round. All ten rounds have the same procedure. You will be paid according to the points achieved in a randomly chosen round.

Participant A and participant B are endowed with 10 points. Participant A can send between 0 and 10 points to participant B. The amount sent is tripled by the experimenter and given to B. A from B selected participant C can now decide how many of the received points to return back to participant A. This back transfer is not tripled. C cannot return more than B received from A. The 10 points that B received from the experimenter remain with B in any case.

Participants A and B are randomly matched in each round. Participant B selects a participant C in each round. The selection procedure runs as follows: All participants C tell the participants B, what percentage of the transferred money they want to remain with B. At this stage each participant C gets a number, which clearly identifies her over all rounds, without compromising her anonymity. Afterwards each participant B selects a participant C. Note that several participants B can simultaneously select a player C. The announcement of participant C concerning the back transfer is not binding. Thus, a selected participant C can reconsider her decision regarding the back transfer. Participant C receives 10 points from the experimenter independent of her decision.

The participants will receive the following payment, if the computer determines this round for the payment:

  • Participant A: 10 points − amount sent by participant A + back transfer,

  • Participant B: 10 points + 3 × (amount sent by participant A) − back transfer,

  • Participant C: 10 points.

At the end of a round the participants will be informed about their points earned in that round.

Sequence of Decisions

A round proceeds on the screen as follows. Firstly, all participants C inform the participants B about the percentage of the transferred money that should remain with B. Secondly, each participant B selects a participant C. Simultaneously participant A decides on the transfer to B by entering a number between 0 and 10 and reports his belief concerning the expected back transfer.

The selected participant C then learns how many points A has sent and how many points B accordingly has received. Then the selected participant C decides on the back transfer by entering the corresponding amount. If a participant C has to make several decisions, they appear simultaneously on the screen in an arbitrary order.

General Instructions for the Participants in the Treatment CTP

This is an English translation of the German instructions of the treatment CTP. We integrated control questions about the experiment into the z‑tree file.

Structure of the Experiment

In this experiment you are always a group of three. In this triad there is always a participant A, a participant B and a participant C. At the beginning of the experiment the computer randomly determines if you are a participant A, B or C. You will keep the same role during the whole experiment.

The experiment lasts for ten rounds. We explain the procedure of one round. All ten rounds have the same procedure. You will be paid according to the points achieved in a randomly chosen round.

Participant A and participant B are endowed with 10 points. Participant A can send between 0 and 10 points to participant B. The amount sent is tripled by the experimenter and given to B. A participant C who has been selected by player B can now decide how many of the received points to return back to participant A. This back transfer is not tripled. C cannot return more than B received from A. The 10 points that B received from the experimenter remain with B in any case.

Participants A and B are randomly matched in each round. Participant B selects a participant C in each round. The selection procedure runs as follows: All participants C tell the participants B, what percentage of the transferred money they want to remain with B. At this stage each participant C gets a number, which clearly identifies her over all rounds without compromising her anonymity. Afterwards each participant B selects a participant C. Note that several participants B can simultaneously select a player C. The announcement of participant C concerning the back transfer is not binding. Thus, a selected participant C can reconsider her decision regarding the back transfer.

C’s salary, which the experimenter pays, is independent from her own decision regarding the back transfers and depends only on the number of participants B selecting that participant C. If no participant B selects a specific participant C, this participant C receives 5 points. For every selection by a player B she gets additional 5 points. That means, if three participants B select a participant C in a round, she receives 20 points. The participants will receive the following payment, if the computer determines this round for the payment:

  • Participant A: 10 points − amount sent by participant A + back transfer,

  • Participant B: 10 points + 3 × (amount sent by participant A)  − back transfer,

  • Participant C: 5 points + 5 points * number of B’s selecting that C.

At the end of a round the participants will be informed about their points earned in that round.

Sequence of Decisions

A round proceeds on the screen as follows. Firstly, all participants C inform the participants B about the percentage of the transferred money that should remain with B. Secondly, each participant B selects a participant C. Simultaneously participant A decides on the transfer to B by entering a number between 0 and 10 and reports his belief concerning the expected back transfer.

The selected participant C then learns how many points A has sent and how many points B accordingly has received. Then the selected participant C decides on the back transfer by entering the corresponding amount. If a participant C has to make several decisions, they appear simultaneously on the screen in an arbitrary order.

Appendix B

Table B.1 Third-Party Influence on Proportions Returned and Investments When Controlling for Gender and Education Background

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Eisenkopf, G., Nüesch, S. Third Parties and Specific Investments. Schmalenbach Bus Rev 17, 151–172 (2016). https://doi.org/10.1007/s41464-016-0014-7

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Keywords

  • Third Parties
  • Specific Investments
  • Residual Control
  • Experiment

JEL Classification

  • D23
  • D33
  • D72