Termination and Coordination in Partnerships

Abstract

It is common practice for firms to pool their expertise by forming partnerships such as joint ventures and strategic alliances. A central organizational problem in such partnerships is that managers may behave noncooperatively in order to advance the interests of their parent firms. We ask whether contracts can be designed so that managers will maximize total profits. We characterize first best contracts for a wide variety of "reasonable" environments and show that efficiency imposes some restrictions on the ownership shares. In addition, we evaluate the performance of two termination contracts that are widely used in practice: the shot gun rule and price competition. We find that although these contracts do not achieve full efficiency, they both perform very well. We provide insight into when each rule is more efficient.

JEL Classification: D20, D23, D44, L14, L22