Sunk investments create hostage situations where premature termination is costly.

Evidence

Suppose a subcontractor invests in specialized fixtures and tooling to grind gears specific to a particular product. The amortized fixed cost of the tooling is £1000 per day and the daily operating costs are £200. Any contract price above - £1200 per day for the subcontractor’s services will allow a positive return on the investment. Suppose further, because the tooling and fixtures can only be adapted to other requirements at considerable cost, that the salvage value of the equipment if sold is £500 (daily rental equivalent). Consequently, if the contract is prematurely terminated the subcontractor faces a daily equivalent loss of £500. — Diego Gambetta, Trust - Making and Breaking Cooperative…, 2532

Categorization

• SHARE: Concrete numbers making the bilateral-monopoly hostage logic precise and teachable.
• XREF: connects to: Private contracts can functionally entrench policy by making future change extremely expensive — Daryl Levinson and Benjamin I. Sachs, Political Entrenchment and Public Law, 163; Existing institutions get redirected toward new problems because sunk costs make replacement costly. — Robert B. McCalla, NATO’s persistence after the cold war, 119; High setup costs and sunk investment make institutional arrangements self-stabilizing. — Daryl Levinson and Benjamin I. Sachs, Political Entrenchment and Public Law, 197