The Role of Market Forces in Assuring Contractual Performance

TLDR

The study investigates the conditions that enable transactors to enforce contracts via repeat‑purchase market mechanisms. The results demonstrate that prices above salvageable production costs—so that nonperformance costs exceed the wealth gain—ensure contractual performance, implying market prices above competitive levels and making advertising investment a positive performance indicator.

Abstract

The conditions under which transactors can use the market (repeat-purchase) mechanism of contract enforcement are examined. Increased price is shown to be a means of assuring contractual performance. A necessary and sufficient condition for performance is the existence of price sufficiently above salvageable production costs so that the nonperforming firm loses a discounted steam of rents on future sales which is greater than the wealth increase from nonperformance. This will generally imply a market price greater than the perfectly competitive price and rationalize investments in firm-specific assets. Advertising investments thereby become a positive indicator of likely performance.