Team Production, Sequential Investments, and Stochastic Payoffs

This paper investigates a team production problem where two parties invest sequentially to generate a joint surplus. We find that the first best can be implemented even if the investment return is highly uncertain. The optimal contract entails a basic dichotomy: it is a simple option contract if investments of both parties are substitutive, and a linear incentive contract if they are complementary. These arrangements can be interpreted in terms of asset ownership, and renegotiation arises in equilibrium after the first agent has invested.