Hold Up Problem
FISHER–GENERAL MOTORS AND THE NATURE OF THE FIRM*
BENJAMIN KLEIN University of California, Los Angeles
Abstract
After working well for more than 5 years, the Fisher Body–General Motors (GM) contract for the supply of automobile bodies broke down when GM’s demand for Fisher’s bodies unexpectedly increased dramatically. This pushed the imperfect contractual arrangement between the parties outside the self-enforcing range and led Fisher to take advantage of the fact that GM was contractually obligated to purchase bodies on a cost-plus basis. Fisher increased its short-term profit by failing to make the investments required by GM in a plant located near GM production facilities in Flint, Michigan. Vertical integration, with an associated side payment from GM to Fisher, was the way in which this contractual hold-up problem was solved. This examination of the Fisher-GM case illustrates the role of vertical integration in avoiding the rigidity costs of long-term contracts.
I. Introduction
damentally changed the way we look at economic institutions. Coase recognized that one must compare the costs of transacting to explain the boundaries of the firm. Without transaction costs, the organization of economic exchange is indeterminate. This forced economists to focus on the costs and benefits of transacting under alternative institutional arrangements. Benjamin Klein, Robert Crawford, and Armen Alchian expanded upon this insight by emphasizing the role of specific investments as a determinant of economic organization.2 The presence of transactor-specific investments, we claimed, created a potential hold-up problem that increased market contracting costs and, therefore, the incentive for vertical integration. Our analysis of the contractual relationship between Fisher Body and General Motors (GM) provided a concrete example of this mechanism. It illustrated the
* Professor of Economics, University of California, Los Angeles. I am indebted to Ryan Sullivan and Joshua
BENJAMIN KLEIN University of California, Los Angeles
Abstract
After working well for more than 5 years, the Fisher Body–General Motors (GM) contract for the supply of automobile bodies broke down when GM’s demand for Fisher’s bodies unexpectedly increased dramatically. This pushed the imperfect contractual arrangement between the parties outside the self-enforcing range and led Fisher to take advantage of the fact that GM was contractually obligated to purchase bodies on a cost-plus basis. Fisher increased its short-term profit by failing to make the investments required by GM in a plant located near GM production facilities in Flint, Michigan. Vertical integration, with an associated side payment from GM to Fisher, was the way in which this contractual hold-up problem was solved. This examination of the Fisher-GM case illustrates the role of vertical integration in avoiding the rigidity costs of long-term contracts.
I. Introduction
damentally changed the way we look at economic institutions. Coase recognized that one must compare the costs of transacting to explain the boundaries of the firm. Without transaction costs, the organization of economic exchange is indeterminate. This forced economists to focus on the costs and benefits of transacting under alternative institutional arrangements. Benjamin Klein, Robert Crawford, and Armen Alchian expanded upon this insight by emphasizing the role of specific investments as a determinant of economic organization.2 The presence of transactor-specific investments, we claimed, created a potential hold-up problem that increased market contracting costs and, therefore, the incentive for vertical integration. Our analysis of the contractual relationship between Fisher Body and General Motors (GM) provided a concrete example of this mechanism. It illustrated the
* Professor of Economics, University of California, Los Angeles. I am indebted to Ryan Sullivan and Joshua
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