Abstract

When the government bargains with a private firm, the firm cares about only its own profits, but the firm's profits may also enter into the government's utility function. As a result, the government will not bargain as aggressively for a low price. This can lead the government to over pay for quality. In contrast to the standard holdup problem, this reverse-holdup problem can give the firm an incentive to over invest in non-contractible quality. The paper also discusses some examples where the reverse-holdup problem may explain excessive quality in government procurement.