Durand-Viel, Laure and Villeneuve, Bertrand (2009): Strategic Capacity Investment under Holdup Threats: The Role of Contract Length and Width.
Download (446Kb) | Preview
This article analyzes the impact of incomplete contracts’ length on investment in a bilateral relationship. The seller has the power to set the contract terms whereas the buyer decides on the investment level, which acts as a cap on future demand. Two-part tariffs succeed at implementing the optimal investment and consumption even if commitment is limited, and the contract’s duration is irrelevant. Interestingly, this efficient solution is rendered possible by subsidies on consumption during the contract. In other terms, duration matters hugely for the contract details (the timing of transfers), not for its performance. Under certain circumstances that we discuss, linear pricing may have to be used, which leads to suboptimal investment. We show that longer contracts are less efficient, meaning that a degree of completeness (pricing width) may be strictly complementary to another one (contract length). The buyer’s surplus increases with respect to the contract duration, whereas the seller loses more in profit than the social surplus decreases. A longer contract actually protects expropriable investors rather than investment itself.
|Item Type:||MPRA Paper|
|Original Title:||Strategic Capacity Investment under Holdup Threats: The Role of Contract Length and Width|
|Keywords:||Long-term Contracts ; Incomplete Contracting ; Infrastructure Investment|
|Subjects:||L - Industrial Organization > L9 - Industry Studies: Transportation and Utilities > L95 - Gas Utilities; Pipelines; Water Utilities
D - Microeconomics > D4 - Market Structure and Pricing > D45 - Rationing; Licensing
D - Microeconomics > D9 - Intertemporal Choice and Growth > D92 - Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
D - Microeconomics > D4 - Market Structure and Pricing > D42 - Monopoly
|Depositing User:||Bertrand Villeneuve|
|Date Deposited:||07. Dec 2009 03:01|
|Last Modified:||12. Feb 2013 23:16|
Aghion, Philippe and Patrick Bolton (1987): “Contracts as a Barrier to Entry”, American Economic Review, 77(3), 388-401.
Balestra, Pietro and Marc Nerlove (1966): “Pooling, Cross Section and Time Series Data in the Estimation of a Dynamic Model: The Demand for Natural Gas”, Econometrica, 34(3), 585-612.
Borenstein, Severin, Jeff Mackie-Mason and Janet Netz (2000): “Exerting Market Power in Proprietary Aftermarkets”, Journal of Economics and Management Strategy, 9(2), 157-88.
Carlton, Dennis and Michael Waldman (2001): “Competition, Monopoly, and Aftermarkets”, NBER Working Paper 8086.
Castaneda, Marco A. (2006): “The Hold-up Problem in a Repeated Relationship”, International Journal of Industrial Organization, 24(5), 953-970.
Chen, Zhiqi, Thomas Wayne Ross and William T. Stanbury (1998): “Refusals to Deal and Aftermarkets”, Review of Industrial Organization, 13, 131-151.
Council of the European Union (2004): Council Directive 2004/67/EC of 26 April 2004 concerning measures to safeguard security of natural gas supply.
Creti, Anna and Bertrand Villeneuve (2004): “Long-term Contracts and Take-or-pay Clauses in Natural Gas Markets”, Energy Studies Review, 13, 75-94.
Crocker, Keith J. and Scott E. Masten (1985): “Efficient Adaptation in Long-term Contracts: Take-or-Pay Provisions for Natural Gas”, American Economic Review, 75, 1083- 1093.
Crocker, Keith J. and Scott E. Masten (1988): “Mitigating Contractual Hazards: Unilateral Options and Contract Length”, RAND Journal of Economics, 19(3), 327-343.
Dubin, Jeffrey.A. and Daniel L. McFadden (1984): “An Econometric Analysis of Residential Electric Appliance Holdings and Consumption”, Econometrica, 52, 118-131.
European Commission (2007): DG Competition report on energy sector inquiry, SEC(2006) 1724, 10 January 2007.
Goldberg, Victor P. (1976): “Regulation and Administered Contracts”, Bell Journal of Economics, 7(2), 426-448.
Hanemann, W. Michael (1984): “Discrete/Continuous Models of Consumer Demand”, Econometrica, 52(3), 541-561.
Hubbard, Glenn and Robert Weiner (1986): “Regulation and Long-term Contracting in US Natural Gas Markets”, Journal of Industrial Economics, 35, 71-79.
Joskow, Paul (1988): “Price Adjustment in Long-term Contracts: The Case of Coal”, Journal of Law and Economics, 31, 47-83.
Morita, Hodaka and Michael Waldman (2004): “Durable Goods, Monopoly Maintenance, and Time Inconsistency”, Journal of Economics and Management Strategy, 13(2), 273-302.
Neumann, Anne and Christian von Hirschhausen (2008): “Long-Term Contracts and Asset Specificity Revisited: An Empirical Analysis of Producer-Importer Relations in the Natural Gas Industry”, Review of Industrial Organization, 32(2), 131-143.
Reitzes, James D. and Glenn A. Woroch (2008): “Competition for Exclusive Customers: Comparing Equilibrium and Welfare Under One-Part and Two-Part Pricing”, Canadian Journal of Economics/Revue canadienne d’économique, 41(3), 1046-1086.
Samuelson, Paul (1947): Foundations of Economic Analysis. Cambridge, MA: Cambridge University Press.
Shapiro, Carl (1995): “Aftermarkets and Consumer Welfare: Making Sense of Kodak”, Antitrust Law Journal, 63, 483-511.
Williamson, Oliver E. (1971): “The Vertical Integration of Production: Market Failure Considerations”, American Economic Review, Papers and Proceedings, 61(2), 112-123.
Available Versions of this Item
- Strategic Capacity Investment under Holdup Threats: The Role of Contract Length and Width. (deposited 07. Dec 2009 03:01) [Currently Displayed]