Hold-Up, Innovation, and Platform Governance

Motivated by large digital platforms, I study a model of platforms choosing fees, upgrades, and governance to compete over a two-sided market of producers and consumers. By solving an interoperability-driven hold-up problem, governance increases producer investment in product quality; however, by preventing fee adjustments, it causes platforms to under-invest in upgrades. This trade-off persists even if platforms choose their preferred level of interoperability, which is higher without governance than with. When governance is necessary for producers to invest in quality, platforms under-provide governance relative to the social optimum. However, when producers invest in quality regardless of governance, platforms over-provide governance.