Distribution and Life

Credible Commitments: Using Hostages to Support Exchange Oliver E. Williamson The American Economic Review Vol. 73, No. 4 (Sep., 1983)   Another Entry in the Goldstein Law Firm’s Series Entitled: Summaries of Great Academic Articles on Law, Economics, and Philosophy in Franchising, Distribution and Life In franchising, credible commitments are created to address the risk of opportunism—e.g., franchisees may be tempted to reduce quality after signing the contract, exploiting the overall reputation of the franchise system. Economic Theories of Credible Commitments and Their Applicability in Distribution and Franchise Contexts General Theory of Credible Commitments Williamson distinguishes between credible commitments and credible threats, both of which are relevant primarily in the context of irreversible, specialized investments. Credible commitments are reciprocal actions undertaken to support alliances and promote exchange, serving efficiency by safeguarding relationships where opportunism and incomplete contracting may undermine cooperation. Such commitments are especially vital when parties make transaction-specific investments that are difficult to protect through simple contractual or legal mechanisms alone. The study of credible commitments otherwise receives less attention than credible threats, largely due to the assumption that courts efficiently enforce contracts—an assumption Williamson challenges. Williamson emphasizes “private ordering,” where parties to exchange relationships develop their own governance structures (such as self-enforcing agreements, use of “hostages,” and bonding mechanisms) to manage the risk that one party will act opportunistically after the other commits irreversible assets. The creation of credible commitments is central to such governance structures, as it deters actions contrary to the mutual interest and substitutes for, […]

Read More