The Economic Lessons of Fisher Body-General Motors

Abstract

The Fisher Body-General Motors case illustrates the costs of using inherently imperfect long-term contracts to solve potential holdup problems, and therefore the advantages of vertical integration. Fisher Body held up General Motors by renegotiating its body supply contract so that, contrary to the original understanding, General Motors made half of the required investments in new body plants. This led to a decline in Fisher Body’s capital to sales ratio and, under the unchanged cost-plus contract terms designed to provide Fisher Body with a return on its equity capital investments, produced a substantial wealth transfer from General Motors to Fisher Body. General Motors accepted this unfavourable contract adjustment because it was operating under a long-term exclusive dealing contract that limited its ability to negotiate with Fisher over co-located body plants. The exclusive dealing contract designed to protect Fisher Body’s original GM specific capacity investments against a potential holdup by General Motors thereby created a Fisher Body holdup of General Motors. The way in which Fisher Body accomplished its holdup demonstrates the importance of distinguishing inefficient holdup threats from efficient actual holdups.

Keywords: holdups, vertical integration, exclusive dealing, contracts

JEL Classification: L14, L22, D21, D23, D86, K12