Vertical Foreclosure in Experimental Markets

Abstract

We report the results of experiments designed to test recent theories of vertical foreclosure. Consistent with the theory, the upstream firm has more difficulty commiting to supply the monopoly quantity in treatments with non-integration and secret contracts than in either treatments with integration or treatments with public contracts. Integration allows the upstream firm to extract a larger share of surplus than public contracts, a bargaining effect which has been underemphasized in the recent foreclosure literature. Motivated by a number of observations that are difficult to reconcile with existing theory, we extend received theory by allowing downstream subjects to have heterogeneous out-of-equilibrium beliefs (a mixture of passive and symmetric beliefs). The resulting model generates a number of surprising results about the structure of optimal contracts. We conclude with a comparison of our results to those of previous experiments on bargaining.

Keywords: vertical foreclosure, vertical integration, market experiments

JEL Classification: L12, L22, C90, D82