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Completing Contracts Ex Post: How Car Manufacturers Manage Car Dealers

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Author Info
Benito Arruñada ()
Luis Garicano
Luis Vázquez

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Abstract

This article illustrates how contracts are completed ex post in practice and, in so doing, indirectly suggests what the real function of contracts may be. Our evidence comes from the contracts between automobile manufacturers and their dealers in 23 dealership networks in Spain. Franchising dominates automobile distribution because of the need to decentralize pricing and control of service decisions. It motivates local managers to undertake these activities at minimum cost for the manufacturer. However, it creates incentive conflicts, both between manufacturers and dealers and among dealers themselves, concerning the level of sales and service provided. It also holds potential for expropriation of specific investments. Contracts deal with these conflicts by restricting dealers’ decision rights and granting manufacturers extensive completion, monitoring and enforcement powers. The main mechanism that may prevent abuse of these powers is the manufacturers’ reputational capital.

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File URL: http://www.econ.upf.edu/docs/papers/downloads/267.pdf
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Publisher Info
Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 267.

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Date of creation: Sep 1998
Date of revision: Jul 2004
Handle: RePEc:upf:upfgen:267

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Web page: http://www.econ.upf.edu/

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Related research
Keywords: Franchising; incomplete contracts; self-enforcement; automobile;

Other versions of this item:

Find related papers by JEL classification:
L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
L62 - Industrial Organization - - Industry Studies: Manufacturing - - - Automobiles; Other Transportation Equipment
L81 - Industrial Organization - - Industry Studies: Services - - - Retail and Wholesale Trade; e-Commerce
K12 - Law and Economics - - Basic Areas of Law - - - Contract Law

This item is featured on the following reading lists:

  1. Studies on the automobile industry
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Klein, Benjamin & Saft, Lester F, 1985. "The Law and Economics of Franchise Tying Contracts," Journal of Law & Economics, University of Chicago Press, vol. 28(2), pages 345-61, May.
  2. Francine Lafontaine & Kathryn L. Shaw, 1996. "The Dynamics of Franchise Contracting: Evidence from Panel Data," NBER Working Papers 5585, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Michael C. Jensen & William H. Heckling, 1995. "Specific And General Knowledge, And Organizational Structure," Journal of Applied Corporate Finance, Morgan Stanley, vol. 8(2), pages 4-18. [Downloadable!] (restricted)
  4. Brickley, James A & Dark, Frederick H & Weisbach, Michael S, 1991. "The Economic Effects of Franchise Termination Laws," Journal of Law & Economics, University of Chicago Press, vol. 34(1), pages 101-32, April.
    Other versions:
  5. Klein, Benjamin, 1995. "The economics of franchise contracts," Journal of Corporate Finance, Elsevier, vol. 2(1-2), pages 9-37, October. [Downloadable!] (restricted)
  6. Darby, Michael R & Karni, Edi, 1973. "Free Competition and the Optimal Amount of Fraud," Journal of Law & Economics, University of Chicago Press, vol. 16(1), pages 67-88, April.
  7. Goldberg, Pinelopi Koujianou, 1996. "Dealer Price Discrimination in New Car Purchases: Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 622-54, June. [Downloadable!] (restricted)
  8. Freixas, Xavier & Guesnerie, Roger & Tirole, Jean, 1985. "Planning under Incomplete Information and the Ratchet Effect," Review of Economic Studies, Blackwell Publishing, vol. 52(2), pages 173-91, April. [Downloadable!] (restricted)
  9. Francine Lafontaine, 1992. "Agency Theory and Franchising: Some Empirical Results," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 263-283, Summer. [Downloadable!] (restricted)
  10. Lutz, Nancy A., 1995. "Ownership rights and incentives in franchising," Journal of Corporate Finance, Elsevier, vol. 2(1-2), pages 103-131, October. [Downloadable!] (restricted)
  11. Brickley, James A. & Dark, Frederick H., 1987. "The choice of organizational form The case of franchising," Journal of Financial Economics, Elsevier, vol. 18(2), pages 401-420, June. [Downloadable!] (restricted)
  12. Lafontaine, Francine, 1993. "Contractual Arrangements as Signaling Devices: Evidence from Franchising," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(2), pages 256-89, October.
  13. Smith, Richard L, II, 1982. "Franchise Regulation: An Economic Analysis of State Restrictions on Automobile Distribution," Journal of Law & Economics, University of Chicago Press, vol. 25(1), pages 125-57, April.
  14. Norton, Seth W, 1988. "An Empirical Look at Franchising as an Organizational Form," Journal of Business, University of Chicago Press, vol. 61(2), pages 197-218, April. [Downloadable!] (restricted)
  15. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring. [Downloadable!] (restricted)
  16. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March. [Downloadable!] (restricted)
    Other versions:
  17. Klein, Benjamin, 1980. "Transaction Cost Determinants of "Unfair" Contractual Arrangements," American Economic Review, American Economic Association, vol. 70(2), pages 356-62, May. [Downloadable!] (restricted)
  18. Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter. [Downloadable!] (restricted)
  19. Klein, Benjamin & Murphy, Kevin M, 1997. "Vertical Integration as a Self-Enforcing Contractual Arrangement," American Economic Review, American Economic Association, vol. 87(2), pages 415-20, May. [Downloadable!] (restricted)
  20. Telser, L G, 1980. "A Theory of Self-enforcing Agreements," Journal of Business, University of Chicago Press, vol. 53(1), pages 27-44, January. [Downloadable!] (restricted)
  21. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August. [Downloadable!] (restricted)
  22. Rubin, Paul H, 1978. "The Theory of the Firm and the Structure of the Franchise Contract," Journal of Law & Economics, University of Chicago Press, vol. 21(1), pages 223-33, April.
  23. Harris, Milton & Raviv, Artur, 1979. "Optimal incentive contracts with imperfect information," Journal of Economic Theory, Elsevier, vol. 20(2), pages 231-259, April. [Downloadable!] (restricted)
  24. Eckard, E Woodrow, Jr, 1985. "The Effects of State Automobile Dealer Entry Regulation on New Car Prices," Economic Inquiry, Oxford University Press, vol. 23(2), pages 223-42, April.
  25. Krueger, Alan B, 1991. "Ownership, Agency, and Wages: An Examination of Franchising in the Fast Food Industry," The Quarterly Journal of Economics, MIT Press, vol. 106(1), pages 75-101, February. [Downloadable!] (restricted)
  26. Klein, Benjamin & Murphy, Kevin M, 1988. "Vertical Restraints as Contract Enforcement Mechanisms," Journal of Law & Economics, University of Chicago Press, vol. 31(2), pages 265-97, October.
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