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Option Contracts in a Vertical Industry
Author(s) -
Antelo Manel,
Bru Lluís
Publication year - 2018
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/manc.12204
Subject(s) - downstream (manufacturing) , leverage (statistics) , market power , bargaining power , economics , industrial organization , production (economics) , microeconomics , vertical integration , business , forward contract , finance , operations management , monopoly , machine learning , computer science , futures contract
We examine the strategic role of horizontal subcontracting through option contracts by a downstream dominant firm competing with a fringe. Downstream production requires an input from imperfectly competitive suppliers. We show that the dominant firm outsources downstream production from fringe firms to gain bargaining clout in the input market. Option contracts are preferred to forwards, because leverage against suppliers is gained at lower contract prices. With no market uncertainty, option contracts do not alter final prices beyond changes caused by unavoidable market power. Whenever demand is uncertain, however, option contracts increase final prices and are therefore harmful for consumers.