Exclusivity Contracts, Insurance and Financial Market Foreclosure

Authors


  • This paper was first circulated as ‘Exclusivity as Inefficient Insurance.’ The authors thank the Editor, Jan Boone, Eric van Damme, Richard Meade, Wieland Müller, Jens Prüfer, Yossi Spiegel, Gijsbert Zwart and anonymous referees for insightful comments, as well as seminar audiences at Tilburg University, the Research Institute of Industrial Economics in Stockholm, the Netherlands Bureau for Economic Policy Analysis (CPB), the Norges Handelshøyskole (NHH) in Bergen, University of Cologne, University of Bayreuth, and conference participants to the 2008 NAKE research day (Utrecht), INFRADAY 2008 (Berlin), TAI 2008 (Washington, D.C.), Larsen & EUI Workshop on ‘Efficiency, Competition and Long Term Contracts in Electricity Markets’ (Florence), CLEEN 2009 (Tilburg), EARIE 2009 (Ljubljana), and CCP Annual Conference 2010 (Norwich). The authors are responsible for any mistakes or shortcomings. Bert Willems is the recipient of a Marie Curie Intra European Fellowship (PIEF-GA-2008-221085). He thanks the Electricity Policy Group at Cambridge University, where part of the research was performed, for its hospitality.

Abstract

We study the trade-off between the positive effects (risk-sharing) and negative effects (exclusion) of exclusivity contracts. We revisit the seminal model of Aghion and Bolton [1987] under risk-aversion and show that although exclusivity contracts induce optimal risk-sharing, they can be used not only to deter the entry of a more efficient rival into the product market but also to crowd out financial investors willing to insure the buyer at competitive rates. We further show that in a world without financial investors, purely financial bilateral instruments, such as forward contracts, achieve optimal risk-sharing without distorting product market outcomes. Thus, risk-sharing alone cannot be invoked to defend exclusivity contracts.

Ancillary