Contract Duration and Relationship-Specific Investments: Empirical Evidence from Coal Markets
Contract Duration and Relationship-Specific Investments: Empirical Evidence from Coal Markets – Joskow 1994
This paper seeks to test empirically the importance of relationship-specific investments in determining the duration of coal contracts negotiated between coal suppliers and electric utilities.
Once the investments are sunk in anticipation of performance, "holdup" or "opportunism" incentives are created ex post which, if mechanisms cannot be designed to mitigate the parties ' ability to act on these incentives, could make a socially cost-minimizing transaction privately unattractive at the contract execution stage. A coal contract generally specifies in advance a method for determining the price that the buyer is obligated to pay for each delivery. My hypothesis is that the more important relationship-specific investments are, the longer will be the period of time (or number of discrete transactions) over which the parties will establish the terms of trade ex ante by contract. I therefore expect to observe that the variation in the agreed upon duration of contractual commitments is directly related to variations in the importance of relationship-specific investments.
As Klein et al. discuss, the sunk investments create a stream of quasi rents that gives one party or the other (or both) some ex post bargaining power. Williamson (1983, p. 526) identifies four distinct types of transaction-specific investments, three of which appear to be relevant to different types of coal supply relationships. The three types of relevance to coal market transactions are: (a) Site Specificity. (b) Physical Asset Specificity (c) Dedicated Assets
Williamson (1983) states that common ownership is the predominant response to site specificity. My work with coal supply arrangements indicates that common ownership (vertical integration) is much more likely to merge for mine-mouth plants than other types of plants, but that contracts are also used to govern exchange for about
This paper seeks to test empirically the importance of relationship-specific investments in determining the duration of coal contracts negotiated between coal suppliers and electric utilities.
Once the investments are sunk in anticipation of performance, "holdup" or "opportunism" incentives are created ex post which, if mechanisms cannot be designed to mitigate the parties ' ability to act on these incentives, could make a socially cost-minimizing transaction privately unattractive at the contract execution stage. A coal contract generally specifies in advance a method for determining the price that the buyer is obligated to pay for each delivery. My hypothesis is that the more important relationship-specific investments are, the longer will be the period of time (or number of discrete transactions) over which the parties will establish the terms of trade ex ante by contract. I therefore expect to observe that the variation in the agreed upon duration of contractual commitments is directly related to variations in the importance of relationship-specific investments.
As Klein et al. discuss, the sunk investments create a stream of quasi rents that gives one party or the other (or both) some ex post bargaining power. Williamson (1983, p. 526) identifies four distinct types of transaction-specific investments, three of which appear to be relevant to different types of coal supply relationships. The three types of relevance to coal market transactions are: (a) Site Specificity. (b) Physical Asset Specificity (c) Dedicated Assets
Williamson (1983) states that common ownership is the predominant response to site specificity. My work with coal supply arrangements indicates that common ownership (vertical integration) is much more likely to merge for mine-mouth plants than other types of plants, but that contracts are also used to govern exchange for about
References: 185 Statistical Models of Truncation, Sample Selection and Limited Dependent Variables and a Simple Estimator For Such Models," Annals of Economic and Social Measurement, 1976, Vol Lee, L. S., Maddala, G. S. and Trost, R. P., "Testing for Structural Change By DMethods in Switching Simultaneous Equations Models," Proceedings of the American Statistical Association, Business and Economics Section, 1979, 461-66