Ownership and Control Rights in Internet Portal Alliances, 1995-1999

Daniel W. Elfenbein and Josh Lerner, 2003.The RAND Journal of Economics

Presented by Wenting (Christy) ZHU

Outline

• Research question

• Portal alliances and the contracting environment

• Dataset

• Analysis

• Conclusion

• Discussion

Research question• The theory of incomplete contracts is central to the modern theory of firm and has

generated powerful insights about governance. Assumption: contracts are incomplete Invocation of transaction costs e.g., unforeseen contingencies, the cost of writing

contracts, the cost of enforcing contracts Non-contractible (neither observable nor verifiable)

• Grossman-Hart-Moore (GHM) property-rights model (1986,1988) Assets in a bilateral relationship should be owned by the party whose marginal effort

has the greatest impact on project success. Relationship-specific but alienable property e.g. machine, land, software and patent Assets ownership creates incentives by its accompanying residual rights of control over

the assets and opportunity to appropriate a majority of the surplus from the project.Specified control rights are commonly used in practice but seldom investigated by

researchers.

• Aghion and Tirole’s (1994) model of contracting for innovation Relative bargaining power is an important determinant of the allocation of property

rights. An R&D alliance between a research unit and a customer providing financial support:

two polar cases The division of assets and specified control rights may be responsive to a concern

(relative bargaining power) other than those that maximize joint surplus.

Research question

• The Internet industry corresponds well with the assumptions of incomplete-contracting modelsThe turbulence of the competitive landscapeThe uncertainty about the future value of decisionsThe perceived need for speed in decision makingThe existent of new but poorly understood measures of

performance and efforts

• How well contract theory explains ownership and the specification of control rights in alliances by Internet portals from 1995 to 1999?

Portal alliances and the contracting environment

• Portals: Internet sites providing (directly or indirectly) a broad array of services and linkages to users, e.g., Yahoo! , Lycos, America Online and producers of browser software. content (stock prices and news headlines) and services (online auctions and

personal e-mail) Source of revenue: the sale of banner advertisements and alliance partnerships

(beneficial for both) Highly uncertain and volatile environment leads to monitoring and enforcement

issues

• Portal alliances as incomplete contracts Specific investments (genuine assets): custom software, tailored content, a

promotion campaign and co-branded website Three types of assets: servers, URL, and customer data Effort decisions of both Parties have an impact on the value of the alliances (non-

contractible) Investigate both asset ownership (residual) and specified control rights

Dataset

• Randomly selected 106 contracts between portals and other firms entered into between 1995 and 1999 from Recap/IT (the date of the agreement and the relative effort required of the two parties)

• Financial information from Compustat and Worldscope in the quarter prior to the signing of the contract (the relative financial strength of the contracting parties)

• Information about the contracting parties’ web traffic from Media Metrix for the month the agreement was signed (the relative traffic on the two parties’ Internet sites)

Dataset

Dataset

Analysis

Ownership: non-independence of the observations and signaling

Analysis

control:

Conclusions

• The ownership of critical elements such as the website address and the customer data was typically assigned to the party whose effort was most critical to the success of the agreement.

• The allocation of control rights appeared most sensitive to the bargaining power of the two contracting parties (relative financial and product-market strength of the two parties).

Discussion

The paper suggests that alliances can be viewed as incomplete contracts. Alliances can exist in three forms, i.e. bilateral contract, unilateral contract, and joint venture. Does the alliance’s form influence (moderate) paper’s findings (main effect)?