This paper studies the dynamic evolution of a joint venture that is initially formed due to the complementary strengths of two firms. We analyze the impact of the investment choices of the two partner firms on the fate of the joint venture. Investments that improve a firm's efficiency in the activity it performs in the joint venture (complementary investments) suffer from an incentive problem since benefits of such investments are shared between the two firms. To minimize the inefficiency caused by this incentive problem, the firm whose input is more valuable to the joint venture should receive a larger share of the joint venture revenues. When each firm invests in learning about the activity performed by its partner (competing investments), the joint venture may itself fail since such investments reduce the synergy arising from complementarity. If firms can choose between the two types of investments, the joint venture suffers from a coordination problem and two type of equilibria coexist: one in which both firms make complementary investments and the joint venture survives with increased complementarity and another in which firms make competing investments and the joint venture is taken over by one of the partners.
Lin, P., & Saggi, K. (1998). Complementarity, investment incentives, and evolution of joint ventures (CPPS Working Papers Series no.87). Retrieved from Lingnan University website: http://commons.ln.edu.hk/cppswp/117