Asset specificity and reputation in cooperation transactions

The institution chosen by some cooperation partners decisively influences both the stability of the cooperation and the payoffs that can be expected by the partners. To investigate these effects the cooperation is modelled as a finitely repeated, non-cooperative game incorporating the properties of the transaction with asset specificity, technical complexity, observability of the partner's actions, and duration being the most important. The institution chosen will then be described by (i) the degree to which the contract is relational and (ii) the distribution of the residual rights to control. To represent these properties, the paper introduces a model of relative leadership incorporating shared control over the transaction. However, players are permanently tempted to defect from the cooperative actions to realize short-term gains at the expense of losing their reputation as correct partner and thereby also losing future payoffs from the cooperation. The aim of the paper is to investigate how the institutional choice can help to stabilize the cooperation securing the partners' payoffs.