Vertical collusion

We characterize collusion involving secret vertical contracts between retailers and their supplier—who are all equally patient (“vertical collusion”). We show such collusion is easier to sustain than collusion among retailers. Furthermore, vertical collusion can solve the supplier's inability to commit to charging the monopoly wholesale price when retailers are differentiated. The supplier pays retailers slotting allowances as a prize for adhering to the collusive scheme and rejects contract deviations. In the presence of competing suppliers, vertical collusion can be sustained using short-term exclusive dealing.     

The demand-boost theory of exclusive dealing

This article unifies various approaches to the analysis of exclusive dealing that so far have been regarded as distinct. The common element of these approaches is that firms depart from efficient pricing, raising marginal prices above marginal costs. We show that with distorted prices, exclusive dealing can be directly profitable and anticompetitive provided that the dominant firm enjoys a competitive advantage over rivals. The dominant firm gains directly, rather than in the future, or in adjacent markets, thanks to the boost in demand it enjoys when buyers sign exclusive contracts. We discuss the implication of the theory for antitrust policy.     

Retailers' choice of product variety and exclusive dealing under asymmetric information

This article considers vertical relations between an upstream manufacturer and a downstream retailer that can independently obtain a low‐quality, discount substitute. The analysis reveals that under full information, the retailer offers both varieties if and only if it is optimal to do so under vertical integration. However, when the retailer is privately informed about demand, it offers both varieties even if under vertical integration it is profitable to offer only the manufacturer's product. If the manufacturer can impose exclusive dealing, then under asymmetric information it will do so and foreclose the low‐quality substitute even if under vertical integration it is profitable to offer both varieties.     

Providers’ affiliation,insurance and collusion

This paper provides a theoretical analysis of the benefits for an insurance company to develop its own network of service providers when insurance fraud is characterized by collusion between policyholders and providers. In a static framework without collusion, exclusive affiliation of providers allows insurance companies to recover some market power and to lessen competition on the insurance market. This entails a decrease in the insured’s welfare. However, exclusive affiliation of providers may entail a positive effect on customers’ surplus when insurers and providers are engaged in a repeated relationship. In particular, while insurers must cooperate to retaliate against a fraudulent provider under non-exclusive affiliation, no cooperation is needed under exclusive affiliation. In that case, an insurer is indeed able to reduce the profit of a malevolent provider by moving to collusion-proof contracts when collusion is detected, and this threat may act as a deterrent for fraudulent activities. This possibility may supplement an inefficient judicial system: it is thus a second-best optimal anti-fraud policy.     

Colluding through suppliers

This article investigates downstream firms’ ability to collude in a repeated game of competition between supply chains. We show that downstream firms with buyer power can collude more easily in the output market if they also collude on their input supply contracts. More specifically, an implicit agreement on input supply contracts with above‐cost wholesale prices and negative fixed fees (that is, slotting fees) facilitates collusion on downstream prices. Banning information exchange about wholesale prices decreases the scope for collusion. Moreover, high downstream prices are more difficult to sustain if upstream rather than downstream firms make contract offers.     

Naked exclusion with minimum‐share requirements

We consider a class of contracts in which buyers commit to giving a seller some minimum share of their total purchases. We show that such contracts can be used by an incumbent seller to reduce the probability of entry by a rival seller when the incumbent can commit to its selling price as part of the contract. We further show that such contracts can be profitable for the incumbent even when exclusive dealing would not be, and even when buyers can coordinate their accept‐or‐reject decisions. The average price paid by the buyers will be higher and welfare will be lower whether or not the incumbent's exclusionary conduct turns out to be successful in preventing entry.     

Market Making Contracts,Firm Value,and the IPO Decision

We examine the effects of secondary market liquidity on firm value and the IPO decision. Competitive aftermarket liquidity provision is associated with reduced welfare and a discounted secondary market price that can dissuade IPOs. The competitive market fails in particular for firms or at times when uncertainty regarding fundamental value and asymmetric information are large in combination. In these cases, firm value and welfare are improved by a contract where the firm engages a designated market maker to enhance liquidity. Such contracts represent a market solution to a market imperfection, particularly for small, growth firms.     

Asymmetric Information, Long-Term Care Insurance, and Annuities: The Case for Bundled Contracts

This article examines the markets for long-term care insurance and annuities when there is asymmetric information and there are costs of administering contracts. Individuals differ in terms of their risk aversion. Risk-averse individuals take more care of their health and are relatively high risk in the annuities market and relatively low risk in the long-term care insurance market. In the long-term care insurance market, both separating and partial-pooling equilibria are possible. However, in the stand-alone annuity market, only separating equilibria are possible. We show, consistent with the extant empirical research, that in the presence of administration costs the more risk-averse individuals may buy relatively more long-term care insurance and more annuity coverage. Under the same assumptions, we show that equilibria exist with bundled contracts that Pareto dominate the outcomes with stand-alone contracts and are robust to competition from stand-alone contracts. The remaining empirical puzzle is to explain why bundled contracts are such a small share of the voluntary annuity market.     

Liquefying a Market: The Transition of LNG to a Traded Commodity

The Liquefied Natural Gas (LNG) industry has grown significantly since it began a half‐century ago, and it will continue to diversify both its sources of supply and the contractual arrangements between suppliers and users. Economic theory says that contracting modes adapt to facilitate gains in efficiency, and that this process of adaptation responds to changes in technological, market, and regulatory factors. When an industry relies heavily on highly specialized assets with limited alternative uses, as is true of LNG, the use of longterm contracts (or vertical integration) will generally be more efficient than short‐term dealings. But once conditions begin to encourage vigorous competition among buyers and sellers, it becomes increasingly economical to rely on shorter‐term (and spot) markets for exchange. The history of the LNG industry supports these theoretical predictions, and illustrates the transition from one contracting mode to another. For most of its history, the specialization and scale of LNG assets dictated the predominant use of long‐term contracting. In recent years, however, market and regulatory changes have raised the demand for short‐term and spot contracting, which in turn has provided the impetus for a virtuous cycle of market liquidity. As buyers and sellers have become increasingly able to obtain or dispose of LNG in an active market, they have needed less protection against the opportunism of trading partners that long‐term contracts have provided in the past. Given this self‐reinforcing process, it is likely that the LNG market will soon look nothing like it did as recently as a decade ago. Buyers and sellers will rely on shorter‐term contracts, and the longerterm contracts that do exist will be linked to spot LNG prices rather than crude oil. Consumers and producers will also benefit from more flexible pricing that more accurately reflects rapidly changing fundamentals of supply and demand.     

Market structure and the competitive effects of vertical integration

We analyze the competitive effects of backward vertical integration when firms exert market power upstream and compete in quantities downstream. Contrasting with previous literature, a small degree of vertical integration is always procompetitive because efficiency gains dominate foreclosure effects, and vertical integration even to full foreclosure can be procompetitive. Interestingly, vertical integration is more likely to be procompetitive if the industry is otherwise more concentrated. Extensions analyze welfare effects of integration and the incentives to integrate. Our analysis suggests that antitrust authorities should be wary of vertical integration when the integrating firm faces many competitors and should be permissive otherwise.     

Accounting, Valuation and Duration of Football Player Contracts

Abstract:   FRS 10 requires investments in player contracts by football companies to be capitalized and amortized. Given the high degree of uncertainty associated with such contracts, it is not clear that this treatment is consistent with asset capitalization criteria. The evidence provided in this paper does not support inconclusively this capitalization requirement in that it indicates weak association of investment in player contracts with three measures of future benefits. In particular, the duration of this association is at most two years, which is shorter than the duration implied by the amortization period reported by sample companies. Nonetheless, other findings suggest that market participants seem to agree with the treatment prescribed by FRS 10 . These results should be of interest to practitioner and standard setters who (axiomatically) regard intangibles acquired in an arm's length transaction as assets.     

Deregulation,Correspondent Banking,and the Role of the Federal Reserve

Intrastate branching deregulation allowed correspondent banks to enter downstream retail deposit markets. Integrated correspondent banks may engage in vertical foreclosure, raising prices to downstream rivals or extracting valuable competitive information. The Federal Reserve would then tend to gain market share from private correspondent banks. Deregulation of restrictions on the formation of multibank holding companies, in contrast, allowed other correspondents to enter, increasing competition. We test these hypotheses using a panel data set of respondent account balances. We find that the Federal Reserve became a more important supplier of correspondent services following branching deregulation and that market power in the correspondent market declined following multibank holding company deregulation. Journal of Economic Literature Classification Numbers: D43, G21, G28, L11.     

Executive Compensation, Strategic Competition, and Relative Performance Evaluation: Theory and Evidence

We examine compensation contracts for managers in imperfectly competitive product markets. We show that strategic interactions among firms can explain the lack of relative performance-based incentives in which compensation decreases with rival firm performance. The need to soften product market competition generates an optimal compensation contract that places a positive weight on both own and rival performance. Firms in more competitive industries place greater weight on rival firm performance relative to own firm performance. We find empirical evidence of a positive sensitivity of compensation to rival firm performance that is increasing in the degree of competition in the industry.     

Vertical integration,foreclosure, and productive efficiency

We analyze the consequences of vertical integration by a monopoly producer dealing with two retailers (downstream firms) of varying efficiency via secret two‐part tariffs. When integrated with the inefficient retailer, the monopoly producer does not foreclose the rival retailer due to an output‐shifting effect. This effect can induce the integrated firm to engage in below‐cost pricing at the wholesale level, thereby rendering integration procompetitive. Output shifting arises with homogeneous and differentiated products. Moreover, we show that integration with an inefficient retailer emerges in a model with uncertainty over retailers' costs, and this merger can be procompetitive in expectation.     

Controlling opportunism in vertical contracting when production precedes sales

In a make‐to‐stock vertical contracting setting with private contracts, when retailers do not observe each other's stocks before choosing their prices, an opportunism problem always exist in contract equilibria but public market‐wide Resale Price Maintenance (RPM) can restore monopoly power. However other widely used tools which do not fall under antitrust scrutiny and require only private bilateral contracts, such as buyback contracts, also allow the producer to fully exercise his monopoly power. We conclude that a more lenient policy toward RPM is unlikely to affect the producer's ability to control opportunism.     

Life Insurance Liabilities at Market Value: An Analysis of Insolvency Risk, Bonus Policy, and Regulatory Intervention Rules in a Barrier Option Framework

This article takes a contingent claim approach to the market valuation of equity and liabilities in life insurance companies. A model is presented that explicitly takes into account the following: (i) the holders of life insurance contracts (LICs) have the first claim on the company's assets, whereas equity holders have limited liability; (ii) interest rate guarantees are common elements of LICs; and (iii) LICs according to the so‐called contribution principle are entitled to receive a fair share of any investment surplus. Furthermore, a regulatory mechanism in the form of an intervention rule is built into the model. This mechanism is shown to significantly reduce the insolvency risk of the issued contracts, and it implies that the various claims on the company's assets become more exotic and obtain barrier option properties. Closed valuation formulas are nevertheless derived. Finally, some representative numerical examples illustrate how the model can be used to establish the set of initially fair contracts and to determine the market values of contracts after their inception.     

Market power,price discrimination,and allocative efficiency in intermediate‐goods markets

We consider a monopolistic supplier's optimal choice of two‐part tariff contracts when downstream firms are asymmetric. We find that the optimal discriminatory contracts amplify differences in downstream firms' competitiveness. Firms that are larger—either because they are more efficient or because they sell a superior product—obtain a lower wholesale price than their rivals. This increases allocative efficiency by favoring the more productive firms. In contrast, we show that a ban on price discrimination reduces allocative efficiency and can lead to higher wholesale prices for all firms. As a result, consumer surplus, industry profits, and welfare are lower.     

DURATION,IMMUNIZATION, AND HEDGING WITH INTEREST RATE FUTURES

The recent advent of the interest rate futures markets has greatly enriched the hedging opportunities of market participants faced with undesired interest rate risk. The variety of futures contracts presently spans a number of instruments with different risk, maturity, and coupon characteristics. This paper modifies the concept of duration and extends the duration hedging approach to cases where futures contracts are used as the hedging instrument. The derived hedge ratios take into account differences in coupon, maturity, and risk for three different regimes. Usage of these hedge ratios should lead to more efficient hedging of interest rate risk.     

Production flexibility, stochastic separation, hedging, and futures prices

We study a dynamic model where uncertainty about interim outputadjustments causes producers to face price, cost and outputuncertainty. Stochastically separable production decisions areindependent of the producer's risk preferences and expectationsand are based on the prevailing futures price as a certain outputprice. Conditions under which futures contracts achieve stochasticseparation are established. Optimal hedging and maturity structureof futures contracts, equilibrium futures prices, and the effectsof futures trading on output are studied. The systematic riskpremium depends on the product of the futures beta and the covarianceof the market return with production revenues.     

Price uncertainty and vertical integration: an examination of petrochemical firms

The petrochemical industry employs assets subject to temporal and site specificity. The OPEC oil price shocks of the 1970s made it difficult to write contracts covering business dealings in the industry. I use this production and economic setting as a natural experiment to test transaction cost theory. In support of the theory, I find that input price uncertainty in the 1970s positively affected the extent of vertical integration by firms into input stages. Moreover, the positive reaction of vertical integration to price uncertainty mainly occurs in transactions subject to asset specificity. I also examine price controls and market power as alternative explanations for vertical integration in the industry, but fail to find support for these hypotheses.