Contracts as a Rent-Extraction Mechanism: An Experimental Study of Stipulated Damages
Claudia M. Landeo
University of Alberta - Department of Economics
Kathryn E. Spier
Harvard University - Law School - Faculty; National Bureau of Economic Research (NBER)
September 8, 2013
This paper studies contracts with stipulated damages as a rent-extraction mechanism. In our theoretical framework, an incumbent seller and a buyer contract in the shadow of a more efficient entrant. Our experimental findings are largely aligned with the theory: (1) Stipulated damages allow the seller to extract value from the entrant and generate market foreclosure; (2) contract renegotiation decreases the likelihood that the incumbent seller charges high stipulated damages to the buyer and increases the likelihood that the entrant charges a high price to the buyer, suggesting that renegotiation weakens the commitment power of stipulated damages and shifts bargaining power to the entrant; and, (3) when contract renegotiation is unavailable, complete information about the entrant's cost reduces the likelihood that the seller charges high stipulated damages to the buyer, indicating that the seller tailors the stipulated damages to the entrant's cost. Non-random deviations in the form of more equitable contract proposals from sellers are also observed. A novel dictator-seller environment suggests that the seller's strategic anticipation of other players' fairness considerations might explain these deviations. Implications for termination fees in mergers and acquisitions and severance packages for managers are discussed.
Number of Pages in PDF File: 66
Keywords: Contracts as a Rent-Extraction Mechanism, Stipulated Damages, Contract Renegotiation, Experiments, Three-Player Bargaining Games, Dictator Environment, Fairness Considerations, Antitrust; Mergers and Acquisitions, Termination Fees, Golden Parachutes, Ultimatum Games
JEL Classification: C72, C91, D62, D86, K12, K21, K22, L12, L42working papers series
Date posted: July 19, 2012 ; Last revised: September 9, 2013
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