VERTICAL RESTRAINTS WITH INCOMPLETE INFORMATION

When a firm contracts with a privately informed retailer, vertical restraints may be insufficient to eliminate distortions arising from having to induce truthful reporting. With franchise fee contracts (which are equivalent to any other "quantity forcing" contract), two distortions arise. The first is the need to transfer surplus to the retailer and the second is a reduction in the marginal return to production. With retail price maintenance contracts, the "first best" outcome of vertical integration is obtainable if the retailer observes private information only about the state of demand. If the retailer observes also private information about retailing costs, both distortions persist. Copyright 1991 by Blackwell Publishing Ltd.

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