For example, more liquid aircraft are more redeployable and should then have longer financing contracts (as in Shleifer and Vishny, 1992), but are also less specific and should then have shorter vertical contracts
(as in Williamson, 1979).
Under vertical contracts
, the processor owns the product in production, while the contractee generally furnishes the labor and facilities for production.
Fumagalli and Motta (2001) consider an industry characterized by secret vertical contracts, and examine a benchmark case where there are two vertical chains, in which two upstream manufacturers sell to two downstream retailers, thereby demonstrating that a downstream merger is more welfare detrimental than an upstream merger.
This development calls for more research on the analysis of vertical contracts under the wage bargaining model.
Upstream Mergers, Downstream Mergers, and Secret Vertical Contracts," Research in Economics 55, 275-289.
The vertical contracts are assumed to establish only the relationship-specificity, but not the transfers from a retailer to its upstream supplier.
Before solving this model, I want to emphasize that transfers between retailers and suppliers are determined by Nash bargaining between the two parties, after the vertical contracts are in place.
Of primary interest is the equilibrium degree of relationship-specificity in the vertical contracts and the resulting incentives of retailers to invest in acquiring market share.
In this sense, it may be the nature of vertical contracts that endogenously determine the magnitude of product switching costs.
Recall that first vertical contract terms are established for the current period (e.
These results have important implications for policymakers who are considering the regulation of vertical contracts
as a means to increase competition in gasoline markets.