Sunk Costs, Fairness, and Disagreement

We study a bilateral trading relationship in which one agent, the seller, can make a non–recoverable investment in order to generate potential gains from trade. Afterwards, the seller makes a price offer that the buyer can either accept or reject. Economic theory predicts that if agents are selfish, neither the level of investment cost nor the buyer’s information about costs should affect the outcome. However, if agents are fairminded, sellers who are known by the buyer to have high investment costs are predicted to charge higher prices. If the investment cost is private information, low–cost sellers should price more aggressively and high–cost sellers price less aggressively than under complete information, giving rise to disagreement and/or underinvestment. Our experiments support these predictions. In particular, many low–cost sellers exploit the informational asymmetry by pretending to be fairminded when they are not: They offer the price that yields an even split of the net surplus for a high–cost seller. Realizing that they may be unfairly treated, some buyers reject this price. JEL classification: L14, C78.