Abstract
We endogenize the contract‐type choice in a vertically related market. We relate that choice to the distribution of bargaining power between the upstream and downstream partner in contract‐terms negotiation. For two wide classes of demand functions, the upstream (downstream) firm prefers a two‐part tariff (linear) contract, and thus, we model the contract‐type choice as a noncooperative game. When a firm has strong bargaining power over the contract terms, risk dominance selects its least‐preferred contract type: the strong firm has more to lose in case of disagreement over the contract type. Under relative symmetry in bargaining power, risk dominance selects the efficient two‐part tariff.
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