Essay about Hold Up Problem

19245 Words Mar 10th, 2012 77 Pages
BENJAMIN KLEIN University of California, Los Angeles

After working well for more than 5 years, the Fisher Body–General Motors (GM) contract for the supply of automobile bodies broke down when GM’s demand for Fisher’s bodies unexpectedly increased dramatically. This pushed the imperfect contractual arrangement between the parties outside the self-enforcing range and led Fisher to take advantage of the fact that GM was contractually obligated to purchase bodies on a cost-plus basis. Fisher increased its short-term profit by failing to make the investments required by GM in a plant located near GM production facilities in Flint, Michigan. Vertical integration, with an associated
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Fisher then refused to make the necessary capital investments required to produce bodies efficiently for GM, in particular refusing to build an important body plant close to a GM production facility in Flint, Michigan. These contractual difficulties were the primary reason GM decided in 1926 to vertically integrate with Fisher Body. The marked change in Fisher’s behavior between the early 1919–24 period and the later 1925–26 period provides important insights into the basic economic forces at work in contractual arrangements. Similar to a biologist

3 Surveys of these studies are provided in Paul L. Joskow, Asset Specificity and the Structure of Vertical Relationships: Empirical Evidence, 4 J. L. Econ. & Org. 95 (1988); Howard A. Shelanski & Peter G. Klein, Empirical Research in Transaction Cost Economics: A Review and Assessment, 7 J. L. Econ. & Org. 335 (1995); and Keith J. Crocker & Scott F. Masten, Regulation and Administered Contracts Revisited: Lessons from Transaction-Cost Economics for Public Utility Regulation, 9 J. Reg. Econ. 5 (1996). 4 R. H. Coase, The Acquisition of Fisher Body by General Motors, in this issue, at 15. 5 Robert F. Freeland, Creating Holdup through Vertical Integration: Fisher Body Revisited, in this issue, at 33. 6 Ramon Casadesus-Masanell & Daniel F. Spulber, The Fable of Fisher Body, in this issue, at 67.

fisher-gm and the nature of the firm