Why Sunk Costs Matter for Bargaining Outcomes: An Evolutionary Approach
Abstract Two bargaining parties play the Nash Demand Game to share a pie whose size is determined by one party's investment decision. Various investment levels are subgame-perfect. Adding the investment decision to Young's evolutionary bargaining model yields the following long-run outcome: efficient investment prevails and the investor's share of the pie approximates die maximum of (i) the smallest share that induces efficient investment, even if the investor expects to appropriate the available pie from every inefficient investment, and (ii) half of the pie. The result favors forward induction to subgame consistency and equity theory to hold-ups. Journal of Economic Literature Classification Numbers: C78, L14.