Haggling for Rents, Relational Contracts, and the Theory of the Firm

I analyze how ownership can be structured to minimize the haggling costs due to contractual incompleteness. I model haggling as a contest in which integration gives the integrating party a relative advantage over the integrated party. In a one-period model, this implies that the contest will become more uneven and social waste reduced, making integration the optimal strategy. In the infinitely repeated version of the model, the parties can also enter a relational contract under which each party promises not to engage in haggling. I show that such a contract is less stable under integration, since the integrating party gains much more from deviating than does any party under non-integration.