Exclusive Contracts and Protection of Investments

Abstract:     
We consider the effect of a renegotiable exclusive contract restricting a buyer to purchase from only one seller on the levels of noncontractible investments undertaken in their relationship. Contrary to some informal claims in the literature, we find that in this setting exclusivity has no direct effect on "internal" investments, i.e. those that are specific to the relationship. The direct effect of exclusivity is instead to increase the "external" investments of the seller (those which enhance the value of the buyer's trade with other sellers) and to reduce those of the buyer. Exclusivity may have an indirect effect on internal investments; the direction of this effect depends on the nature of any complementarities or substitutabilities between external and internal trades and investments. We relate these findings to existing informal discussions of the role of exclusivity in protecting investments. We also examine the effects of exclusivity on aggregate welfare, the private incentives of the buyer-seller coalition to use it, and the resulting externality on other potential suppliers.

Number of Pages in PDF File: 49

JEL Classification: D80, D82

working papers series