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Option Contracts in a Vertical Industry

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Listed:
  • Manel Antelo
  • Lluís Bru

Abstract

We examine the strategic role of horizontal subcontracting through option contracts by a downstream dominant firm competing with a fringe. Downstream production requires an input from imperfectly competitive suppliers. We show that the dominant firm outsources downstream production from fringe firms to gain bargaining clout in the input market. Option contracts are preferred to forwards, because leverage against suppliers is gained at lower contract prices. With no market uncertainty, option contracts do not alter final prices beyond changes caused by unavoidable market power. Whenever demand is uncertain, however, option contracts increase final prices and are therefore harmful for consumers.

Suggested Citation

  • Manel Antelo & Lluís Bru, 2018. "Option Contracts in a Vertical Industry," Manchester School, University of Manchester, vol. 86(4), pages 533-557, July.
    • Handle: RePEc:bla:manchs:v:86:y:2018:i:4:p:533-557
    DOI: 10.1111/manc.12204
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    More about this item

    JEL classification:

    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production

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