March 2006 Vol. 104 No. 5 THE REVIEW

Boilerplate and Economic Power in Auto Manufacturing Contracts

Omri Ben-Shahar & James J. White

Manufacturing contracts in the automotive industry have served a canonical role in the economic theory of contract and bargaining. The famous story of General Motors’ relationship with its supplier Fisher Body in the 1920s is a landmark illustration of the problem of contractual hold up, underlying a prominent theory of vertical integration and the nature of the firm. The theoretical fascination with automotive procurement contracts is well deserved. There may be no other merchant-to-merchant contractual template that governs such fantastic economic stakes—hundreds of billions of dollars per year—and implemented through a process that involves almost no negotiation of the legal terms. Boilerplate rules these transactions.

There is a long line of law-and-economics scholarship studying the attributes of standard-form terms in contracts between sophisticated parties in high-stakes transactions. One of the benchmark predictions in this literature is that contractual terms have to be efficient if they are to be consistently used by the parties. Any rent-seeking power that a party has should be translated into a price advantage; it should not be used to dictate selfish but inefficient performance terms. Further, since legal terms such as warranties and remedies affect the costs borne by the parties, we expect that sophisticated parties will be “pricing” the terms and will be ready to redraft terms that cost more than they save. A study of automobile contracts provides an opportunity to test these predictions. These are transactions in which economic power is unevenly distributed; much dickering takes place over prices and product design; but everything else is packed into boilerplate. Every party reads the boilerplate and understands its legal effect and its economic consequences. Do strong parties dictate efficient boilerplate and extract rents through prices and other purely distributive clauses? Do they tailor their terms to maximize their net gains from the transactions?

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