Naked Exclusion: An Experimental Study of Contracts with Externalities

This paper reports the results of an experiment designed to assess the ability of an incumbent seller to profitably foreclose a market with exclusive contracts. We use the strategic environment described by Rasmusen, Ramseyer, and Wiley (1991) and Segal and Whinston (2000) where entry is unprofitable when sufficiently many downstream buyers sign exclusive contracts with the incumbent. When discrimination is impossible, the game resembles a stag-hunt (coordination) game in which the buyers' payoffs are endogenously chosen by the incumbent seller. Exclusion occurs when the buyers fail to coordinate on their preferred equilibrium. Two-way non-binding pre-play communication among the buyers lowers the power of exclusive contracts and induces more generous contract terms from the seller. When discrimination and communication are possible, the exclusion rate rises. Divide-and-conquer strategies are observed more frequently when buyers can communicate with each other. Exclusion rates are significantly higher when the buyers' payoffs are endogenously chosen rather than exogenously given. Finally, secret offers are shown to decrease the incumbent's power to profitably exclude.