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

1. Ownership and control rights in internet portal alliances, 1995-1999Daniel W. Elfenbein and Josh Lerner, 2003Published in The RAND Journal of Economics Wonjoon Chung School of Labor and Employment Relations (LER) September 18th, 2012

2. 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

3. 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

4. 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?

5. 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 cost Ownership Bargaining power Ownership Asset Specified Property Rights Residual Property Rights When unspecified by contract

6. Contractual incompleteness and its consequences • 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 issue

7. 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

8. 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 Compustatand 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

9. Results - Ownership

10. Results - controls

11. 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)

12. 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

13. Contributions • An empirical articlethat 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