WORKING PAPER NO. 141 Vertical Restraints under Asymmetric Information: On the Role of Participation Constraints

We investigate the impact on optimal contracting of a type-dependent reservation utility within a sequential monopolies environment with adverse selection and moral hazard. The welfare and private properties of contracts controlling both the retail price and the sales level are compared with those restricting only sales. When contracts are chosen non-cooperatively and the retailer’s reservation utility severely (resp. softly) affects the agency problem between an upstream and a downstream firm, although being optimal from the supplier viewpoint, retail price restrictions are shown to be detrimental (resp. beneficial) to consumers. If contracts are chosen cooperatively, retail price restrictions fail to maximize joint-profits whenever the reservation utility has a negligible impact on optimal allocations. In constrast to the Chicago view, a laissez-faire policy might not be optimal in both cases