Contractual Networks, Contract Design, and Contract Interpretation: The Case of Credit Cards
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Description
Transaction cost economics predicts that firms join together in a network when doing so reduces the costs of exchange or otherwise enhances value for those who participate in the network. Caffagi's taxonomy of networks indicates that network participants may employ various forms to accomplish these objectives, including serial or linear contracts (A-B, B-C, C-D) or concentric contracts in which one central party simultaneously contracts with multiple others, who may or may not contract with one another, but who are dependent on each other for success. Participants in a supply chain, for example, may engage in linear contracting. Concentric contracting, on the other hand, may be used by franchisors who transact individually with each franchisee, while franchisees are unlikely to transact with each other; nevertheless, the success of each franchisee depends to some extent on the performance of others. In each case, the network device is appropriate if it enhances the ability of participants to realize benefits not otherwise available or to induce cooperation among network participants that might otherwise be difficult to obtain if parties acted unilaterally or if obligations were restricted to those with whom they transacted bilaterally. In each of these examples, the potential participants in a network include multiple firms within the same industry. The likelihood that firms will participate in a common network poses an interesting contracting problem. One traditionally thinks of different firms within an industry as competitors who seek to gain an advantage over each other with respect to common customers and suppliers. The success of the network of which the potential competitors are members, however, depends critically on the willingness of participants to cooperate. Self-interested competition in all respects may ultimately, in classic prisoners' dilemma fashion, redound to the detriment of all participants. Thus, the fledgling literature on networks notes that they are often characterized by an interesting mix of competition and cooperation. Indeed, the mixture of cooperation and competition at least partially explains why a single, global contract may not be employed to govern the relationship among all participants in a network. Cooperation may be necessary to capture certain gains that any given firm could not generate by unilateral action. But the possibility of competition means that parties will not want common terms to apply to all aspects of the relationship, since some participants will desire to exploit an advantage they have over other participants by employing different contract terms than would be possible in a global agreement. What determines when network participants should cooperate and when they should compete? Law external to contract will dictate some of the boundaries, since cooperation over some aspects of the relationship, such as the setting of prices, may violate antitrust or other regulatory mandates. But even where cooperation is permissible, parties may avoid instantiating that result in a set of contractual obligations, perhaps out of concern that cooperation will induce lock-in effects that make subsequent change in industry practices more costly and more difficult, or perhaps because cooperation is more efficiently induced by informal reputational mechanisms than by threat of legal sanction for defection. At the very least, however, one would expect that the scope of contractual cooperation will be linked to the value of the network itself. That is, cooperation should be embodied in legal obligations where joint efforts that might not otherwise occur could increase the value of the network itself. This does not necessarily mean that all participants will benefit from any particular act of cooperation. The prisoners' dilemma predicate for the network implies that, absent a contractual agreement, some parties would be better off if they did not cooperate, but rather defected from the cooperative solution. It is for that reason that some form of contractual obligation is necessary to induce cooperation. If all parties benefited from cooperation ex post, then arguably no contractual obligation would be necessary to induce that behaviour. Contracting permits parties to share expectationally in the gains from cooperation: those who might do better ex post by defecting have opportunities to contract ex ante for a share of the enhanced value of the network that cooperation generates. Intranetwork contracts for cooperation, therefore, should exist in at least the following cases. First, one would expect to find obligations to cooperate where there is a dominant solution to the multiparty prisoners' dilemma, such as a clearly efficient pattern of behaviour or risk allocation that parties might not otherwise adhere to because they anticipate defection by others. Second, cooperation should exist to specify a solution to a coordination problem. Here, participants would presumably be willing to cooperate as long as they are aware of the solution to which all other participants will also migrate. Third, one would expect to find obligations to cooperate where doing so takes the form of assigning monitoring or other responsibilities to participants best positioned to undertake them, and thus to avoid free riding or other inducements for defection.
Source Publication
The Organizational Contract: From Exchange to Long-Term Network Cooperation in European Contract Law
Source Editors/Authors
Stefan Grundmann, Fabrizio Cafaggi, Giuseppe Vettori
Publication Date
2013
Recommended Citation
Gillette, Clayton P., "Contractual Networks, Contract Design, and Contract Interpretation: The Case of Credit Cards" (2013). Faculty Chapters. 725.
https://gretchen.law.nyu.edu/fac-chapt/725
