Barriers to Entry by Lock-in Contracts: Breach Penalties and Specific Investments as Raising Rivals' Costs Strategies

Abstract

The paper is an extension of the contributions provided by Aghion and Bolton (1987), Chung (1994, 1996), and Spier and Whinston (1995)--among others--to the analysis of the trade-off between the enforcement of incomplete contracts characterised by specific investments and the market foreclosure deriving from the resulting high exit costs. A summarization of the economic principles involved in the antitrust case United States v. United Shoe Machinery Corporation will clarify the nature of such a trade-off. When specific investments are made by the incumbent agent, potential competition will affect the incentive to efficiently invest depending on the nature and the extent of the breach penalties enforced by external authorities. We will conclude that in an incomplete contract framework with unverifiable specific investments but verifiable exit options, the degree of assets specificity in a contractual relationship depends on the nature of the breach penalties enforced by external authority and on the expected efficiency of potential competitors. In such a context antitrust authorities are called to evaluate the market efficiency induced by the penalty regime adopted and the impact of the strategic selection of technological innovations on competitors entry.