This article addresses two issues in understanding whether contracting
subject to renegotiation can provide the right incentives for investments: the
degree of specificity of investments and the sequentiality of investments. The
paper considers an environment in which the seller makes a specific
investment and then the buyer undertakes an investment. Assuming the
general investment, recent articles argue that option contracts can achieve
the first best outcome. This article shows, however, that their result is not
robust when the first investment is specific. In particular, option contracts
cannot do better than no contract. Moreover, this paper proves that
contracting replicates at best no contract. Our results imply that the value of
contracting depends heavily on whether the first investment is general or
specific in the sequential investment environment.