Abstract

http://ssrn.com/abstract=2112665
 
 

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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


Abstract:     
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, L42

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Date posted: July 19, 2012 ; Last revised: September 9, 2013

Suggested Citation

Landeo, Claudia M. and Spier, Kathryn E., Contracts as a Rent-Extraction Mechanism: An Experimental Study of Stipulated Damages (September 8, 2013). Available at SSRN: http://ssrn.com/abstract=2112665 or http://dx.doi.org/10.2139/ssrn.2112665

Contact Information

Claudia M. Landeo (Contact Author)
University of Alberta - Department of Economics ( email )
Edmonton, Alberta T6G 2H4
Canada
HOME PAGE: http://www.arts.ualberta.ca/~econweb/landeo/
Kathryn E. Spier
Harvard University - Law School - Faculty ( email )
1575 Massachusetts
Hauser 302
Cambridge, MA 02138
United States
(617) 496-0019 (Phone)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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