Formula Pricing and Profit Sharing in Inter‐Firm Contracts

Lowell R. Jacobsen, Roger Blair and Francine Lafontaine ()

Managerial and Decision Economics, 2015, vol. 36, issue 1, 33-43

Abstract: Ronald Coase viewed transaction cost minimization as a central goal of contracting and organizational decisions. We discuss how a solution to the traditional successive monopoly problem that has not been discussed in the literature can economize on such costs. Specifically, we show that when we allow for profit sharing between upstream and downstream firms, a simple formula pricing contract can be used to generate the vertically integrated level of profits. This simple contract, empirically, would take the form of the standard linear wholesale price contracts that are ubiquitous in vertical contexts, even those where we might expect successive monopoly to be an issue. We discuss the advantages of the proposed contract from a transaction cost perspective. We also discuss some of its limitations, in particular the likelihood of misrepresentation of costs, and ways in which such misrepresentation might be addressed in the contract. Copyright © 2014 John Wiley & Sons, Ltd.

Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:wly:mgtdec:v:36:y:2015:i:1:p:33-43

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