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Termination Damages and Relational Contracts

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  • Lee, Myoungki
  • Wu, Steven Y.

Abstract

We study the economic impact of proposed legislation requiring processors to pay termination damages to growers when contractual relationships are prematurely severed. In doing so, we derive the optimal relational contract in the presence of asset specificity, ex post market power on the part of processors, and the presence of an exogenous shock that might destroy gains from trade from contracting. The optimal contract then provides a credible framework for assessing how government intervention might affect optimizing behavior of contracting parties. We conclude that termination damages would not be distortionary and would not undermine processors' ability to design effective relational incentives. However, the distribution of surplus would be affected.

Suggested Citation

  • Lee, Myoungki & Wu, Steven Y., 2005. "Termination Damages and Relational Contracts," 2005 Annual meeting, July 24-27, Providence, RI 19184, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    • Handle: RePEc:ags:aaea05:19184
    DOI: 10.22004/ag.econ.19184
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    References listed on IDEAS

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    1. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, December.
    2. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-1367, November.
    3. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June.
    4. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-480, March.
    5. Rachael E. Goodhue, 2000. "Broiler Production Contracts as a Multi-Agent Problem: Common Risk, Incentives and Heterogeneity," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(3), pages 606-622.
    6. Lewin-Solomons, S., 2000. "Asset Specificity and Hold-up in Franchising and Grower Contracts: A Theoretical Rationale for Government Regulation?," Cambridge Working Papers in Economics 0013, Faculty of Economics, University of Cambridge.
    7. Wu, Steven Y., 2003. "Regulating Agricultural Contracts: What are the Tradeoffs?," Choices: The Magazine of Food, Farm, and Resource Issues, Agricultural and Applied Economics Association, vol. 18(1), pages 1-4.
    8. MacLeod, W Bentley & Malcomson, James M, 1998. "Motivation and Markets," American Economic Review, American Economic Association, vol. 88(3), pages 388-411, June.
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    Cited by:

    1. Wu, Steven Y., 2006. "Contract theory and agricultural policy analysis: a discussion and survey of recent developments," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 50(4), pages 1-20, December.
    2. Steven Y. Wu, 2006. "Contract theory and agricultural policy analysis: a discussion and survey of recent developments ," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 50(4), pages 490-509, December.

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    Keywords

    Agricultural and Food Policy;

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