Contracts as a Rent-Extraction Mechanism: An Experimental Study of Stipulated Damages under Social Preferences
Claudia M. Landeo
University of Alberta - Department of Economics
Kathryn E. Spier
Harvard University - Law School - Faculty; National Bureau of Economic Research (NBER)
July 26, 2014
This paper reports the results of an experiment on 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. In equilibrium, rent extraction through stipulated damages and market foreclosure occur only when contract renegotiation is not permitted. As predicted, we find that contract renegotiation induced the sellers to propose the lowest stipulated damages and the entrants to offer the highest price more frequently. When armed with complete information about the entrant's cost, the incumbent fine-tuned the stipulated damages to reflect this more precise information. As a consequence, lower exclusion of high-cost entrants from the market occurred. Other experimental results were not anticipated. First, it is predicted that the sellers will propose the highest stipulated damages when renegotiation is not permitted. We find that, although a small group of sellers exhibited a behavior aligned with theory, the majority of sellers departed from that behavior and made more generous offers. Second, our theory predicts that stipulated damages lose their rent-extraction value when renegotiation is permitted. Our data indicate that the incumbent seller extracted value from the more efficient entrant in renegotiation environments as well. Findings from the dictatorial seller and buyer-entrant communication treatments suggest that social preferences influenced players' behavior.
Number of Pages in PDF File: 47
Keywords: Stipulated Damages; Rent Extraction; Market Foreclosure; Renegotiation; Social Preferences; Experiments
JEL Classification: C72, C91, D86, K12, K21, L42
Date posted: July 19, 2012 ; Last revised: July 26, 2014
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