Vertical Exclusion with Endogenous Competiton Externalities
43 Pages Posted: 28 Sep 2012
Date Written: May 2012
In a vertical market in which downstream firms have private information about their productivity and compete for consumers, an upstream firm posts public bilateral contracts. When downstream firms are risk-neutral without wealth constraints, the upstream firm offers the input to all retailers. When they are sufficiently risk averse it sells to one, thereby eliminating externalities among downstream firms that necessitate the payment of risk premia. By similar reasoning exclusion is also optimal with downstream wealth constraints. Thus exclusion arises when contracts are fully observable and downstream firms are ex ante symmetric. The result is robust to a number of extensions.
Keywords: Adverse selection, Exclusive contracts, Limited liability, Risk
JEL Classification: D82, L22, L42
Suggested Citation: Suggested Citation