How Bargaining Power Affects Non-Price Terms in Contracts

Abstract

While practitioners and commentators in industry invoke bargaining power to explain patterns in non-price contract terms, conventional law and economics scholarship contends that bargaining power should affect only the price and not other contract terms. This paper looks at the impact of bargaining power on non-price terms, such as warranties, termination rights and dispute resolution provisions, when the value and cost of these terms varies across contracting parties, and when such values are private information. We conceptualize bargaining power as having three primary components: (1) lack of competition; (2) power to dictate the contract terms; and (3) power to commit not to renegotiate. In the extreme cases in which one or the other party enjoys overwhelming bargaining power, the efforts of that party to capture a larger share of the surplus by screening or signaling will compromise the efficiency of the non-price terms. We demonstrate that this incentive is mitigated or disappears when bargaining power is more evenly shared between the parties. This analysis provides a basis for understanding the intuition among market participants that the impact of bargaining power extends beyond price terms. We also suggest implications for legal policy, particularly the contract law doctrine of unconscionability.