Advances in New Institutional Analysis series
Edited by Claude Ménard and Michel Ghertman
Chapter 13: Adaptation in Long-term Exchange Relations: Evidence from Electricity Marketing Contracts
Dean V. Williamson INTRODUCTION This research takes up an old, enduring question about what contracting parties can achieve in a long-term contract that they cannot achieve by a sequence of short-term contracts.1 In the environment examined here, the action depends on the role of renegotiation in enabling contracting parties to adapt terms of exchange over time to changing conditions.2 As a matter of course, short-term contracts enable parties to renegotiate and adapt terms of exchange after a short term (Myers, 1977: 158; Williamson, 1971: 116). Thus, if adaptation over the long term is important, why would parties ever commit to long terms? One part of the answer advanced here depends on ‘friction’: long-term contracts allow parties to program fewer, rather than more, costly instances of renegotiation. A familiar tradeoff obtains between enabling flexibility in contractual relations and the costs of supporting that flexibility: a sequence of short-term contracts may afford greater flexibility, but programming a sequence of short-term contracts also entails programming a sequence of costly renegotiations (Masten and Crocker, 1985; Crocker and Masten, 1988). Managing trade-offs between flexibility and renegotiation suggests that ‘efficient adaptation’ can be an interesting economic problem (Crocker and Masten, 1991), but that is just one consideration in a much larger contracting problem. The first-order action pertains to investment incentives (Williamson, 1971: 116). In the environment examined here, adaptation may involve expanding, withdrawing, or tuning up production capacity over the course of (possibly) long-term exchange. A difficulty is that one party’s decision to expand, withdraw, or...
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