The Strategic Value of Incomplete Contracts for Competing Hierarchies (original) (raw)

The Strategic Value of Incomplete Contracting in a Competing Hierarchies Environment

We explore the strategic value of quantity forcing contracts in a competing manufacturer-retailer hierarchies environment under both adverse selection and moral hazard. Manufacturers dealing with (exclusive) competing retailers may prefer to leave contracts silent on retail prices, whenever other aspects of the retailers' activity remain nonveri.able. Two effects are at play once one moves from retail price maintenance to quantity forcing. First, restricting the number of screening instruments available to manufacturers has a detrimental effect on their pro.ts as it leaves more possibilities to retailer for getting information rents. Second, such restriction may provide manufacturers with strategic power in that it affects downstream competition. Under some conditions related to the severity of the adverse selection problem and the nature of externalities across retailers, the latter effect may rationalize the use of quantity forcing contracts in a game of competing hierarchies. RPM may be either detrimental or bene.cial to welfare depending upon the type of non-market externalities that retailers impose on each other. JEL Classification: D2, D23, D82, K21.

When vagueness induces indirect competition: strategic incompleteness of contracts

Economic Theory, 2002

A class of employment contracts entailing production targets and consequent rewards is studied. In a nondiscriminatory environment, a principal hiring many agents faces the problem of writing a common contract which induces the highest possible effort from each one of his agents. While a very high target may get the best out of highly skilled agents, low skilled ones tend to shirk. On the other hand, although low targets make every agent put positive effort, there are efficiency losses from the high skilled agents. Also, in such environments the principal often has better information regarding the skills of all his agents than what each agent has regarding the rest of the agents at work. We show that if skills of agents are sufficiently close, the informed principal earns strictly higher profits by offering incomplete contracts as against being specific, as incomplete contracts reduce flow of information and induce indirect competition amongst agents.

The Strategic Value of Quantity Forcing Contracts

American Economic Journal: Microeconomics, 2010

We explore the strategic value of quantity forcing contracts in a manufacturerretailer environment under both adverse selection and moral hazard. Manufacturers dealing with (exclusive) competing retailers may prefer to leave contracts silent on retail prices, whenever other aspects of the retailers' activity remain nonverifiable. Two effects are at play when moving from retail price maintenance to quantity forcing. First, restricting screening possibilities may increase retailers' rent. Second, such restriction affects downstream competition. This latter effect may justify using quantity forcing contracts and, more generally, shed light on a novel source of contractual incompleteness.

Contractual Incompleteness and the Nature of Market Interactions

SSRN Electronic Journal, 2002

We provide experimental evidence that contractual incompleteness, ie, the absence of third party enforcement of workers’ effort or the quality of the good traded causes a fundamental change in the nature of market interactions. If contracts are complete the vast majority of trades are initiated by public offers. Most trades take place in one-shot transactions and the contracting parties are

Contract Contingency in Vertically Related Markets

SSRN Electronic Journal, 2016

We study the optimal contract choice of an upstream monopolist producing an essential input that may sell to two vertically differentiated downstream firms. The upstream supplier can offer an exclusive contract to one of the firms or non-exclusive contracts to both firms. Each of the latter can be made contingent or not on the breakdown of the negotiations between the upstream supplier and the rival downstream firm. The distribution of bargaining power during the contract terms negotiations is the main driving force of the monopolist's choices. A powerful supplier always opts for an exclusive contract. By contrast, a weaker supplier offers non-exclusive contracts and makes each of them contingent or non-contingent such as to guarantee the most favorable outside option in its negotiations. Our main results hold under an horizontally differentiated downstream market too.

Contract Unobservability and Downstream Competition

Problem definition: In this paper, we consider a supply chain with a manufacturer and two retailers who are contracted through wholesale prices or two-part tariffs. We depart from the existing literature by assuming that contract terms between the manufacturer and a retailer are not observed by the rival retailer. Academic/practical relevance: While the existing literature typically assumes that they are common knowledge in the market, contract terms may not be observed by rival retailers under certain circumstances. This paper contributes to the literature by studying the effect of contract unobservability on supply chain performance. Methodology: We use game theoretical methods to find the equilibrium. When there are multiple equilibria, we adopt passive beliefs as an equilibrium refinement criterion. Results: We find that certain established results regarding observable supply chain contracts do not always apply when those contracts become unobservable to competing retailers. In particular, compared to when using two-part tariff contracts, the manufacturer may benefit from using wholesale price contracts when contract terms are unobservable. Moreover, the total industry profit may increase under wholesale price contracts. Managerial implications: Our results offer an alternative explanation for the popularity of the wholesale price contracts and suggest that members of the supply chain must take unobservability into account when selecting the right contracts. We also offer new insights into buyback contracts and downstream mergers under unobservable contracts.

Vertical Contracts as Strategic Commitments

2020

Recent literature has shown that when retailers cannot observe contracts between a manufacturer and their rivals, the manufacturer will be unable to obtain the vertically integrated profit using two-part tariff contracts alone. It has been suggested that vertical restraints, such as RPM and exclusive territories, are observable and thus permit the manufacturer to obtain profits closer to the vertically integrated level. Observability, however, is not sufficient. To serve as a strategic commitment mechanism, a vertical contract must be enforceable as well. We show that the vertical contracts that have been the focus of the recent literature are not self-enforcing but must be externally enforced. We find that in practice the enforceability condition has not been met. This suggests that models which rest on the premise that vertical restraints are strategic commitments do not provide general explanations of these practices .

Disclosure Regime and Bargaining in Vertical Markets

SSRN Electronic Journal

We study the strategic implications of the disclosure regime of vertical contracts. We show that the downstream competition mode and fierce (as proxied by product's differentiation) as well as the upstream market structure play a significant role in the observability (or not) of the vertical contract's terms. When a common supplier bargains with each retailer over a two-part tariff contract, interim observability offers a useful tool to ease the commitment problem, by offering wholesale price below marginal cost. That is also the case under linear wholesale contracts or even Bertrand competition in the product market. On the other hand, under dedicated exclusive suppliers, it is more profitable to bargain over interim unobservable contracts. Policymakers could increase social welfare by encouraging interim observability (unobservability) when firms compete in quantities (prices).

Incomplete Contracts and the Internal Organization of Firms

Journal of Law, Economics, and Organization, 2014

We survey the theoretical and empirical literature on decentralization within firms. We first discuss how the concept of incomplete contracts shapes our views about the organization of decision-making within firms. We then overview the empirical evidence on the determinants of decentralization and on the effects of decentralization on firm performance. A number of factors highlighted in the theory are shown to be important in accounting for delegation, such as heterogeneity and congruence of preferences as proxied by trust. Empirically, competition, human capital and IT also appear to foster decentralization. There are substantial gaps between theoretical and empirical work and we suggest avenues for future research in bridging this gap.

Incomplete contracts and strategic ambiguity

The American Economic Review, 1998

Why are observed contracts so often incomplete in the sense that they leave contracting parties' obligations vague or unspecified? Traditional answers to this question invoke transaction costs or bounded rationality. In contrast, we argue that such incompleteness is often an ...