Solving a hold-up problem may harm all firms: downstream R&D and transport-price contracts

In vertical relations, by raising input price after downstream research and development (R&D) investment, upstream firms can extract the R&D benefit and have an incentive to set higher input price. As downstream firms underinvest for fear of this hold-up by upstream firms, outputs and input-demand shrink, and all firms become worse off. Previous literature emphasizes that a fixed-price contract in which upstream firms first commit themselves to input prices and downstream firms subsequently invest can resolve the hold-up problem and make all firms better off. By contrast, we show that in a vertical relation between firm-specific carriers and exporters, the fixed-price contract of transport price can make all firms worse off because an efficiency improvement in exporters intensifies inter-regional competition. We also discuss the robustness of the result.