Ebook A Transaction Cost Model of Contract Choice: The Case of Petroleum Exploration
Contracts in which part of the payment structure is conditional on the ex post value of a good or service being exchanged are commonly found when the exchange of property rights occurs under substantial uncertainty about the value of the good or service being exchanged.
A standard explanation for contracts containing conditional payments focuses on the risk sharing and incentive properties of different contractual arrangements. For example, in well known principal agent models by Grossman and Hart [1983], McAfee and McMillan [1986] and others, conditional and fixed payments impose risk differentially and provide differing incentives for input use by the contracting parties.
An alternative explanation for these types of payment structures focuses on the effects of transaction costs. Models by Cheung [1969], Williamson [1979], Barzel [1982, 1987], Leffler and Rucker [1991], Allen and Lueck [1999], Black [2000], and others demonstrate that the structures of contracts involving resources with uncertain value are influenced by the transaction costs incurred by the contracting parties prior to, as well as after, a contract is signed. The purpose of this study is to extend the growing transaction cost literature by developing a transaction cost model of oil and gas mineral rights leasing contracts.
When the rights to potential petroleum deposits are exchanged, compensation consists of both lump sum and conditional payments. These payment types differ with respect to the type, size, and timing of transaction costs incurred by the contracting parties. Under the considerable uncertainty attending petroleum exploration, the existence of pre sale and post sale measurement, enforcement, negotiation, monitoring, and other transaction costs can constrain the gains from different contract structures. The choice of payment structure is seen as an optimizing decision under the constraints of these transaction costs.
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