Wonjoon ChungSchool of Labor and Employment Relations (LER)September 18th, 2012

Ownership and control rights in internet portal alliances, 1995-1999

Daniel W. Elfenbein and Josh Lerner, 2003

Published in The RAND Journal of Economics

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About the authors…

• Daniel W. Elfenbein• Associate Professor of Organization and Strategy at Washington University at St. Louis• Ph.D. (Business Economics), Harvard University

• Josh Lerner• Jacob H. Schiff Professor of Investment Banking at Harvard University• Ph.D. (Economics), Harvard University

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Introduction

• Incomplete-contract model: Central to the modern firm theory

• 2 Incomplete-contract models in the paper• Grossman-Hart-Moore property-rights framework (GHM model) : Grossman & Hart (1986) and Hart & Moore, (1990)• Aghion and Tirole’s (1994) model of contracting for innovations

To examine alliance contracts between Internet portals and other firms using a contract-theory perspective

• In a new contracting setting: Internet portal industry • Characteristics of Internet environment fits well with

assumptions of incomplete-contract models 3

Contractual incompleteness and its consequences

• Formal contracts i.e., written• Incomplete contract due to information conditions

• Incomplete contract by invocation of transaction costs• Unforeseen contingencies;• The cost of writing contracts; and• The cost of enforcing contacts.

• If contracts cannot fully specify the usage of the asset in every state of the world, then who gets the right to choose?

• Inability to observe effort and enforce agreement: problems • Property-rights approach? 4

Essence of Property-rights theory

• The ownership of an asset: incentive to make asset-specific investments

• Transferring ownership of an asset: a benefit and a cost5

AssetSpecifiedPropertyRights

Ownership

When unspecified by contract

Bargaining power

Residual PropertyRights

Ownership

• Ex ante allocation of ownership and specified control rights may not maximize ex post surplus

• e.g., Aghion & Tirole (1994)• R&D alliance between a research unit and a customer• Ex ante bargaining power: 2 cases• Research unit has bargaining power: efficiently allocation, similar

to Grossman & Hart, 1986• Customer has it: inefficient allocation

• Raised relative bargaining power issue6

Contractual incompleteness and its consequences

Portal alliances and the contracting environment

• Portals: Internet sites that provides a wide array of services and linkages to users• Began operations in 1994, introduction of www

• Benefits from alliances: Portals and partner firms

• Alliance contract for 3 types of assets• The servers used by the alliances / The uniform resource locator (URL) /

The customer data

• The effort decisions of both parties were likely to have a substantial impact on the value of the alliance

• Asset ownership (residual control rights) and specified control rights: similar role based on property right theory

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Data set and Analysis

• A set of 106 contracts between portals and other firms between 1995 and 1999 from Recap/IT• Supplementary financial information from Compustat

and Worldscope• IVs• The calendar dates of agreement• Relative effort required in the alliance (+1 / 0 / -1)• Traffic on internet properties of portal and partner:

Portal’s sites> Partners’ (a month before the signing of the agreement)• Relative financial health of the two parties

• Potential problems: • Non-independence of the observations; and • Signalling

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Results - Ownership

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Results - controls

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Conclusion

• To examine how well contract theory explains ownership and specification of control rights in alliances by internet portals from 1995 to 1999

• Results support for models of incomplete contracting:

• The division of ownership was sensitive to the allocation of effort between parties (consistent with prediction of the GHM Models)

• The allocation of control rights was sensitive to relative bargaining power of the two parties (consistent with prediction of the Aghion and Tirole (1994) model)

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Remaining questions

• Other observable measures of performance and effort• See Elfenbein & Lerner (2002)• Designing alliance contracts: exclusivity and

contingencies in internet portal alliances

• Two separate theories to explain division of ownership and control rights – technological consideration

• How bargaining changes under conditions in which both parties have upward bias in the assessment of the value of internet traffic 12

Contributions

• An empirical article that explores the influence of transaction and institutional-level factors on alliance formation

• Finds empirical evidence that the structure of the alliance contract provides significant support for the predictions of incomplete-contract theories

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