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Vertical Contracting and Downstream Competition

  • Author(s): Huang, Zheng
  • Advisor(s): Watson, Joel
  • et al.
Abstract

When downstream firms collude, upstream firms' profits are often reduced. Yet upstream firms currently lack legal avenues to directly counter downstream collusion. This dissertation explores the strategic use of vertical contracting to restrict downstream collusion.

I model a two-tier supply chain where a monopolist upstream firm faces a group of collusive downstream firms. I take a game-theoretic approach to analyzing the behavior of the firms. Equilibrium results are derived, comparative statics are studied, and comparison is made with outcomes under downstream competition. The welfare implications of the upstream firm's contracting strategy are also discussed. The model demonstrates that a monopolist upstream supplier is able to use nonlinear pricing contracts to restrict downstream collusion, which results in a total quantity even larger than that under linear pricing in downstream competition. Consumers and society benefit from this restriction.

A theoretical result derivative of a slight variation of the model predicts a possible linkage between upstream and downstream competition. A change in upstream competition is predicted to cause a change in downstream competition in the opposite direction. This prediction is tested in an initial empirical study of the maritime shipping and the shipbuilding industries. Yearly financial data were collected of 9 large shipbuilding companies and 14 large shipping companies over the period 2003 to 2015, which were used to derive a measure of competition for each of the two industries. Preliminary evidence suggests that upstream competition has a negative impact on downstream competition. The finding of this study lends empirical support to the main model.

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