– When will A+B create more value? – What are arguments to be skeptical of?
But... • A+B merged versus A and B standalone are not the only options • Maybe some of the value can be created / captured through – Joint ventures? – Licensing agreements? – Contracting for services? • Economies of scale and scope seem to determine the optimal size and scope of firms … but mergers are not the only way to exploit them 9
10 Today’s question • When should efficiencies be captured through ownership vs. contracts?
11 The limits to contracting • What makes contracting and ownership different? “If contracts are “complete”, there is no difference between contracting and ownership” – Coase • The Coase Theorem: If perfect property rights, no transactions costs, then ownership has not baring on efficiency • Of course, in the real world, contracts are not “complete”
Incomplete contracts • The starting point of modern contract theory is the observation that contracting is costly – Costly to think ahead and foresee all contingencies – Costly to negotiate over them – Costly to write down what you’ve agreed on – Difficult for courts to verify terms of contracts ex post • The result is that real-world contracts only cover a small set of possible contingencies • In the real world, ownership matters because it affects outcomes that are difficult to contract on explicitly 12
Independence vs. Ownership 13
Example: McDonalds • McDonalds owns valuable assets e.g., • Michigan & South Water store earns higher profits with assets than without • Michigan & South Water store using it does not diminish value to Ohio & LaSalle (Rock & Roll) store • Therefore efficient for both stores to use them 14
• Choice #1: McDonalds owns Michigan & South Water store • Choice #2: Michigan & South Water store is a franchise 15 Example: McDonalds
16 Example: McDonalds • Consider the decisions that the manager of a McDonalds store has to make • Some will be easy to contract on because there are foreseeable and verifiable – What items to put on the menu – What prices to charge – Store hours – How much McDonalds will charge for inputs – What kind of sign they have to put out front
17 Example: McDonalds • Other actions are easy to verify but may be difficult to foresee at the time of contracting – Growth of health consciousness leads McDonalds to add salads to the menu – Rising beef prices mean McDonalds has to renegotiate the prices it charges franchisees – McDonalds decides it’s important for its stores to be open later to serve younger demographic – McDonalds wants to renovate stores to use more traditional signage and design elements
18 Example: McDonalds • Still other issues are easy to anticipate but difficult to verify and therefore hard to contract on – How much effort the manager exerts to motivate employees – How clean she keeps the store – The quality of customer service provided – Quality control of food product • Distinction: “observable” versus “verifiable”.
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- Fall '15