Bargaining Between Collaborators of a Stochastic Project

Some projects require collaboration between firms to implement. The expected return from such a project can change over time due to evolving market conditions or the arrival of new information. Each firm may also choose an outside option rather than collaborating. In such a case, when is the joint project implemented, and how do firms split the return? To address these questions, the paper studies a continuous‐time model of bilateral bargaining with a stochastic cake and outside options. I show that the combination of stochastic cake, outside options, and uneven bargaining power creates a hold‐up problem that leads to insufficient delay. The joint project is implemented too early, or firms take outside options too quickly, causing both the ex‐ante probability of agreement and its timing to be sub‐optimal. Increasing the frequency of counteroffers, which balances bargaining power, improves efficiency by reducing the hold‐up. More importantly, the paper finds that a more balanced bargaining power can lead to Pareto‐improving outcomes.