Testing, hold up and the dynamics of preferences

This paper presents an overlapping generations model with cultural transmission of preferences in an economy in which players face a hold up problem. One of the players, the firm, can use a testing technology which allows him to imperfectly monitor his partner's behaviour. This technology is completely useless with homogeneous preferences. We obtain that in the stable steady state of the economy there is a mixed distribution of preferences where both selfish and other-regarding preferences are present in the population. Moreover, with a good testing technology, the steady state is characterized by the first-best result in the investment decisions. JEL Classification: C78, D23, D63 The authors acknowledge financial support from the Spanish Ministry of Science and Technology project SEC2001-2763. This paper has also benefited from comments of participants in the XXVIII Spanish Symposium of Economic Analysis in Seville (Spain), in the International Workshop on Social and Behavioral Economics in Valencia (Spain), in the 2nd World Congress of the Game Theory Society in Marseille and in the VI Spanish Meeting on Game Theory and Practice in Elche (Spain).