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Efficient Exclusion

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  • Moen, Espen R
  • Riis, Christian

Abstract

In an important paper, Aghion and Bolton (1987) argue that a buyer and a seller may agree on high liquidation damages in order to extract rents from future suppliers. As this may distort future trade, it may be socially wasteful. We argue that Aghion and Bolton's analysis is incomplete in some respects, as they do not model the entry of new suppliers. We construct a model where entry is costly, so that entering suppliers have to earn a quasi-rent in order to recoup the entry cost. Reducing an entrant's profits by the help of a breach penalty then reduces the probability of entry in the first place, thus making a breach penalty less attractive for the contracting parties. We show that the initial buyer and seller only have incentives to include a breach penalty if there is excessive entry without it. Forcing the initial buyer and seller to eliminate the breach penalty reduces welfare.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5257.

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Date of creation: Sep 2005
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Handle: RePEc:cpr:ceprdp:5257

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Keywords: breach penalties; efficiency; entry; exclusive contracts;

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  1. Paul Klemperer, 2004. "Auctions: Theory and Practice," Online economics textbooks, SUNY-Oswego, Department of Economics, number auction1, Spring.
  2. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
  3. Engelbrecht-Wiggans Richard, 1993. "Optimal Auctions Revisited," Games and Economic Behavior, Elsevier, vol. 5(2), pages 227-239, April.
  4. B. Douglas Bernheim & Michael D. Whinston, . "Exclusive Dealing," Working Papers 96008, Stanford University, Department of Economics.
  5. Burguet, Roberto & Sakovics, Jozsef, 1996. "Reserve Prices without Commitment," Games and Economic Behavior, Elsevier, vol. 15(2), pages 149-164, August.
  6. Peters, Michael, 1997. "A Competitive Distribution of Auctions," Review of Economic Studies, Wiley Blackwell, vol. 64(1), pages 97-123, January.
  7. Motta,Massimo, 2004. "Competition Policy," Cambridge Books, Cambridge University Press, number 9780521016919.
  8. Innes, Robert & Sexton, Richard J, 1994. "Strategic Buyers and Exclusionary Contracts," American Economic Review, American Economic Association, vol. 84(3), pages 566-84, June.
  9. McAfee, R Preston, 1993. "Mechanism Design by Competing Sellers," Econometrica, Econometric Society, vol. 61(6), pages 1281-1312, November.
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