Ownership and Investment in Electronic Networks

Abstract

We employ the theory of incomplete contracts to examine the relationship between own­ership and investment in electronic networks such as the Internet and interorganiza­tional information systems. Electronic networks represent an institutional structure that has resulted from the introduction of information technology in industrial and consumer markets. Ownership of electronic networks is important because it affects the level of network-specific investments, which in turn determine the profitability, and in some cases the viability, of these networks. In our analysis we define an electronic network as a set of participants and a portfolio of assets. The salient concept in this perspective is the degree to which network partici­pants are indispensable in making network assets productive. We derive three main results. First, if one or more assets are essential to all network participants, then all the assets should be owned together. Second, participants that are indispensable to an asset essential to all participants should own all network assets. Third and most important, in the absence of an indispensable participant, and as long as the cooperation of at least two participants is necessary to create value, sole ownership is never the best form of ownership for an electronic network. This latter result implies that as the leading network participants become more dis­pensable, we should see an evolution toward forms of joint ownership.

Keywords: Incomplete Contracts, Investment Externalities, Internet Ownership, Network Externalities, Network Investment, Network Ownership