Termination clauses in partnerships

Abstract

We show that when designing a partnership agreement partner firms may prefer not to specify how to allocate the commonly owned assets should there be an early termination of the contract. By not including such a clause, firms induce litigation before a Court with positive probability. Firms create this ex-post inefficiency in order to increase the levels of non-contractible investments, i.e. increase the ex-ante efficiency. The absence of an asset allocation clause works as a “discipline device” that mitigates the hold-up problem within the partnership. In our set-up, no other contract but that without an asset allocation clause can credibly create an ex-post inefficiency.