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Making exit costly but efficient: the political economy of exit clauses and secession

Martijn Huysmans and Christophe Crombez

No 586433, Working Papers of Department of Management, Strategy and Innovation, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Management, Strategy and Innovation, Leuven

Abstract: This article presents a political economic analysis of exit from federations. Over time, members’ benefits from being in a federation can fluctuate because of changes in the state of the world. If a member stops benefitting, it may wish to secede i.e. exit the federation. Based on a real options model, we show that state-contingent exit penalties can induce socially efficient exit decisions. In addition to the substantive implications, this represents a methodological contribution to real options theory. Even if ex-ante specified exit penalties cannot be made state-contingent, they may still enhance social welfare by preventing secession wars. This finding runs counter to the dominant view in the literature that exit clauses should be avoided in federations. As a first test of the model, we derive five hypotheses and show that they hold for the breakup of Yugoslavia and all cases known to us of federations with an exit clause.

Keywords: Exit clauses; Secession; Federalism; Real options (search for similar items in EconPapers)
Date: 2017-06
New Economics Papers: this item is included in nep-cdm and nep-pol
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Published in LICOS - Discussion paper series 397/2017 , pages 1-41

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