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Fisher—General Motors and the Nature of the Firm

Author(s): By Benjamin Klein
Reviewed work(s):
Source: Journal of Law and Economics, Vol. 43, No. 1 (April 2000), pp. 105-142
Published by: The University of Chicago Press for The Booth School of Business of the University of Chicago
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FISHER–GENERAL MOTORS AND THE
NATURE OF THE FIRM*
BENJAMIN KLEIN
University of California, Los Angeles
Abstract
After working well for more than 5 years, the Fisher Body–General Motors
(GM) contract for the supply of automobile bodies broke down when GM’s demand
for Fisher’s bodies unexpectedly increased dramatically. This pushed the imperfect
contractual arrangement between the parties outside the self-enforcing range and
led Fisher to take advantage of the fact that GM was contractually obligated to pur-
chase bodies on a cost-plus basis. Fisher increased its short-term profit by failing
to make the investments required by GM in a plant located near GM production
facilities in Flint, Michigan. Vertical integration, with an associated side payment
from GM to Fisher, was the way in which this contractual hold-up problem was
solved. This examination of the Fisher-GM case illustrates the role of vertical inte-
gration in avoiding the rigidity costs of long-term contracts.
I. Introduction
Ronald Coase’s landmark contribution in The Nature of the Firm fun- 1
damentally changed the way we look at economic institutions. Coase recog-

nized that one must compare the costs of transacting to explain the bound-
aries of the firm. Without transaction costs, the organization of economic
exchange is indeterminate. This forced economists to focus on the costs and
benefits of transacting under alternative institutional arrangements.
Benjamin Klein, Robert Crawford, and Armen Alchian expanded upon
this insight by emphasizing the role of specific investments as a determinant
of economic organization.2 The presence of transactor-specific investments,
we claimed, created a potential hold-up problem that increased market con-
tracting costs and, therefore, the incentive for vertical integration. Our anal-
ysis of the contractual relationship between Fisher Body and General Mo-
tors (GM) provided a concrete example of this mechanism. It illustrated the
* Professor of Economics, University of California, Los Angeles. I am indebted to Ryan

Sullivan and Joshua Wright for superb research assistance and to Scott Masten for extensive
comments on an earlier draft.
1
R. H. Coase, The Nature of the Firm, 4 Economica (n.s.) 386 (1937).
2
Benjamin Klein, Robert G. Crawford, & Armen A. Alchian, Vertical Integration, Appro-
priable Rents and the Competitive Contracting Process, 21 J. Law & Econ. 297 (1978).
[Journal of Law and Economics, vol. XLIII (April 2000)]
 2000 by The University of Chicago. All rights reserved. 0022-2186/2000/4301-0005$01.50
105

106 the journal of law and economics
problems that arise when transactors use imperfect long-term contracts to

solve hold-up problems created by specific investments and also illuminated
the economic motivation for GM’s use of vertical integration. The Fisher-
GM case has been cited by numerous researchers, and many studies have
since empirically documented the relationship between vertical integration
and specific investments in widely varying circumstances.3
Coase rejects this idea that specific investments are a determinant of ver-
tical integration. He claims that hold-up problems created by the presence
of specific investments normally can be handled satisfactorily with long-
term contracts without requiring vertical integration. He also specifically re-
jects the view that the Fisher-GM case involved hold-up behavior.4 Coase
claims that my description of the Fisher-GM case, which has become an
accepted element of transaction cost theory, does not reflect what actually
occurred.
In what follows, I first reexamine in detail the operation of the long-
term contract entered into by Fisher Body and GM in 1919. Contrary to
Coase and to the two other papers by Robert Freeland5 and by Ramon
Casadesus-Masanell and Daniel Spulber 6 included in this issue, the facts
of the Fisher-GM case are shown to be fully consistent with the hold-up
description provided in Klein, Crawford, and Alchian. The evidence unam-
biguously demonstrates that while the contract that governed the relation-
ship between Fisher Body and GM initially worked well, this contract
broke down in 1925 when GM’s demand for Fisher bodies increased dra-
matically. Fisher then refused to make the necessary capital investments
required to produce bodies efficiently for GM, in particular refusing to
build an important body plant close to a GM production facility in Flint,
Michigan. These contractual difficulties were the primary reason GM de-
cided in 1926 to vertically integrate with Fisher Body.
The marked change in Fisher’s behavior between the early 1919–24 pe-
riod and the later 1925–26 period provides important insights into the basic
economic forces at work in contractual arrangements. Similar to a biologist
3
Surveys of these studies are provided in Paul L. Joskow, Asset Specificity and the Struc-
ture of Vertical Relationships: Empirical Evidence, 4 J. L. Econ. & Org. 95 (1988); Howard
A. Shelanski & Peter G. Klein, Empirical Research in Transaction Cost Economics: A Re-
view and Assessment, 7 J. L. Econ. & Org. 335 (1995); and Keith J. Crocker & Scott F.
Masten, Regulation and Administered Contracts Revisited: Lessons from Transaction-Cost
Economics for Public Utility Regulation, 9 J. Reg. Econ. 5 (1996).
4
R. H. Coase, The Acquisition of Fisher Body by General Motors, in this issue, at 15.
5
Robert F. Freeland, Creating Holdup through Vertical Integration: Fisher Body Revis-
ited, in this issue, at 33.
6
Ramon Casadesus-Masanell & Daniel F. Spulber, The Fable of Fisher Body, in this is-
sue, at 67.

fisher-gm and the nature of the firm 107
doing medical research on how the human body functions by studying the
onset of disease, we can learn a great deal about the economics of contrac-
tual arrangements by studying the conditions under which the Fisher-GM
contract failed. In particular, examining the operation of the Fisher-GM
contract helps us to understand why transactors may choose what appear
to be obviously imperfect contract terms, the conditions under which such
imperfect contracts are likely to break down, and the advantages of vertical
integration under these circumstances.
The answers to these questions rest on the role transactors assign to
contract terms. Transactors choose the imperfect contract terms that gov-
ern their relationship based on the expected effectiveness of the terms in
supporting self-enforcement of the underlying contractual understanding.
It is only when market conditions develop unexpectedly, as they did in
the Fisher Body–GM case, that the relationship moves outside the ‘‘self-
enforcing range’’ defined by these imperfect contract terms and the transac-
tors’ reputational capital. When this occurs, one transactor will find it
profitable to use the court to take advantage of the imperfect, legally en-
forceable contract terms in order to violate the intent of the contractual un-
derstanding. The Fisher Body–GM case not only provides a useful illustra-
tion of these economic forces but also illuminates the economic advantages
of vertical integration, namely, the increased flexibility transactors gain
from not having to use a rigid long-term contract to supplement their lim-
ited reputational capital.
II. The Holdup of General Motors by Fisher Body
A. The Fisher Body–General Motors 1919 Supply Agreement

The Fisher Body–GM case concerns a contract signed in 1919 for Fisher
Body to supply automobile bodies to GM.7 Fisher Body, in order to produce
GM’s closed auto bodies, had to make an investment in plant and equip-
ment that was specific to GM. Casadesus-Masanell and Spulber rely on the
fact that the closed bodies produced by Fisher and other body producers at
this time were composite (wood framed and metal skinned) to claim that
7
The contractual agreement between Fisher Body and GM can be found in the minutes
of the Board of Directors of Fisher Body Corporation for November 7, 1919. The agreement
is described in Letter from Fred and Charles Fisher to the General Motors Corporation (Sep-
tember 25, 1919), Gov’t Trial Ex. No. 426, United States v. E. I. Du Pont de Nemours &
Co., General Motors, et al., Civil Action 49C-1071, 126 F. Supp. 235 (N.D. Ill. 1954); 353
U.S. 586 (1957); 366 U.S. 316 (1961). Much of the evidence of the relationship between
Fisher Body and GM is taken from this antitrust case brought by the United States Depart-
ment of Justice in 1949 that challenged the 1917–19 acquisition by Du Pont of approximately
23 percent of the GM voting common stock.

Fisher’s investments were not GM-specific. However, although composite

bodies required less specific capital investment than the pure metal bodies
that began to be used in the mid-1930s, these composite closed bodies re-
quired substantially more specific investment than the largely wooden open
bodies they replaced.8 As we shall see below, the economic necessity for
body plants to be located close to the particular automobile production fa-
cility they supplied also made body plant investments somewhat relation-
ship specific.
Fisher Body’s GM-specific investments created a potential for GM to
hold up Fisher. After Fisher made these investments, GM could have threat-
ened to reduce its demand for Fisher-produced bodies, or even to terminate
its relationship with Fisher completely, unless Fisher reduced its body
prices to GM.
Coase is correct that this situation, in and of itself, is insufficient to gen-
erate vertical integration. In fact, GM and Fisher Body used a long-term
(10-year) exclusive dealing contract to prevent GM from holding up Fisher
and, thereby, to encourage Fisher to make the GM-specific investments.
Since GM was contractually obligated to buy all of its automobile bodies
from Fisher for a period of 10 years, GM could not threaten to move its
demand to another supplier, and Fisher’s specific investments were pro-
tected against GM’s hold-up threat.
Obviously, the parties recognized that a contract that essentially gave
Fisher a 10-year monopoly over the supply of auto bodies to GM also must
set a reasonable (competitive) price or price formula at which supply was
8
A description of the production process for automobile bodies during the 1920s is given
in Roger White, Body by Fisher: The Closed Car Revolution, 29 Automobile Q. 46, 50, 51
(August 1991). White notes that automobile bodies (which were supplied along with automo-
bile interiors) required significant labor input, with workers having ‘‘to cut dies, lumber, and
sheet steel, screw and glue frames together, install upholstery, paint and varnish exteriors,
and perform other time-consuming manual tasks.’’ But he also notes that ‘‘large sums of
capital were needed to make unique dies for each metal panel required, and huge facilities
were needed to store bodies while paint and varnish dried.’’ Robert Thomas documents that
the introduction and success of the new mostly closed models and the movement to annual
model changes after 1924 dramatically increased industry capital expenditures on the nonde-
preciable tooling necessary to make closed body dies (from a level of $12 million in 1921
to $36 million in 1928). See Robert Paul Thomas, Style Change and the Automobile Industry
during the Roaring Twenties, in Business Enterprise and Economic Change 122, table 3, 131
(Louis P. Cain & Paul J. Uselding eds. 1973). Because of these large capital investments,
the automobile-body-producing industry was fundamentally restructured during the 1920s,
shifting from ‘‘a large number of companies, most of which had previously built carriages
and wagons’’ at the turn of the century (Thomas G. Marx & Laura Bennett Peterson, Theory
versus Fact in the Choice of Organizational Form: A Study of Body and Frame Production
in the Automobile Industry 12–13 (unpublished manuscript, 1995)) to a much smaller num-
ber of firms that made composite closed bodies, most important Fisher Body, Briggs Manu-
facturing, and the Murray Corporation of America. See White, supra; Body by Briggs,
Special-Interest Autos 24–29 (November-December 1973).

to occur. Fisher and GM agreed upon a formula where the price was set
equal to Fisher’s ‘‘variable cost’’ plus 17.6 percent. The 17.6 percent up-
charge presumably was designed to cover Fisher’s anticipated capital and
overhead costs.9 In addition, the contract further protected GM with a most-
favored-purchaser clause.10
B. General Motors Did Not Obtain Control of Fisher Body in 1919

General Motors, in connection with its entering into a long-term body
supply contract with Fisher in 1919, also acquired a 60 percent interest in
Fisher Body.11 However, purchase of the 60 percent interest did not provide
GM with control of Fisher Body. A voting trust agreement that ran until
October 1, 1924, was established in 1919 in connection with the purchase,
and this agreement provided the Fisher brothers with continued effective
control of the Fisher Body Corporation.12 The Fisher Body shares purchased
by GM, along with some of the shares owned by Fred Fisher and Louis
Mendelssohn (a major early investor in the Fisher Body Corporation), were
placed in the voting trust, and a unanimous decision by the trust’s four
trustees, including Fred Fisher, was required in order for the trust to vote
its shares on any action.13
In addition to the Fisher brothers retaining control of Fisher Body during
1919–24, they also retained operational authority. In 1919 the six Fisher
brothers entered into employment contracts with Fisher Body for a period
9
An upcharge over variable costs, rather than a formula based on Fisher’s total cost, was
probably used because Fisher was selling automobile bodies to many different companies
and it was difficult to isolate and measure the capital and overhead costs associated with GM
shipments.
10
As a practical matter this term guaranteed only that GM would not pay more than other
buyers of ‘‘like products.’’ See Letter from Fred and Charles Fisher to the General Motors
Corporation, supra note 7. Since Fisher could argue that GM’s bodies were unique, this most-
favored-purchaser clause was not a very effective constraint on pricing. In addition, as we
shall see, GM sales and Fisher’s hold-up potential became so large that, if necessary, it would
have been profitable for Fisher to concentrate its business entirely on GM to avoid this
clause.
11
The purchase consisted of 300,000 shares of newly issued Fisher Body common stock at
$92 per share, or $27.6 million. See General Motors Corporation, Report of General Motors
Corporation for the Fiscal Year Ended December 31, 1919, at 12–13 (1920) [hereinafter all
such reports will be cited as ‘‘(year) Annual Report of General Motors Corporation’’]; Law-
rence Seltzer, A Financial History of the American Automobile Industry 218 (1928).
12
Voting Trust Agreement (November 24, 1919), Gov’t Trial Ex. No. 429, Du Pont, 126
F. Supp. 235.
13
The four trustees were Fred Fisher, Louis Mendelssohn, W. C. Durant, and Pierre S. du
Pont. Although Coase and Freeland recognize the unanimity provisions of the voting trust,
Casadesus-Masanell and Spulber miss this and incorrectly claim that GM obtained 50 percent
control of Fisher Body in 1919.

of 5 years, also running through October 1, 1924.14 Each Fisher brother re-
ceived as compensation, in addition to nominal salaries,15 a 5 percent share
of Fisher Body profits (amounting in total to about $7.5 million over the 5-
year agreement) plus the dividends payable on their remaining 20 percent
(100,000 shares) of Fisher Body stock (amounting in total to about $5 mil-
lion over the 5-year agreement).16
In 1924, shortly before expiration of these employment agreements (and
the voting trust), the Fisher brothers extended their relationships with Fisher
Body. In lieu of their 5 percent profit shares, they each received shares in
the Managers Securities Company, GM’s stock incentive plan,17 and were
required to remain as managers of Fisher Body until 1929 before they could
fully redeem their GM shares in the plan. In addition, two brothers (Fred
and Lawrence) became employees of GM and members of the GM execu-
tive committee.18
C. 1919–24: The Fisher–General Motors Contract Works Well

In analyzing the Fisher-GM body supply contract, it is crucial to distin-
guish between the early period of operation, from 1919 to 1924, when the
contract functioned well, and the period 1925–26, when the contract was
used by Fisher to hold up GM and was the primary motivation for GM’s
acquisition of the remaining 40 percent interest of Fisher Body.
During 1919–24 Fisher Body initially used money from its sale of shares
14
Agreement between Fisher Body Corporation and Fred J. Fisher (the eldest brother)
(December 9, 1919), Gov’t Trial Ex. No. 430, Du Pont, 126 F. Supp. 235; Direct Testimony
of Lawrence Fisher, at 1569 (stenographer’s minutes), Du Pont, 126 F. Supp. 235.
15
For example, Fred Fisher received $33,000 per year from Fisher Body Corporation and
$7,200 per year from Fisher Body Company of Canada. Agreement between Fisher Body
Corporation and Fred J. Fisher, supra note 14.
16
The 1919 agreement required that up to two-thirds of Fisher Body’s net earnings would
be paid out annually to shareholders in dividends until the annual dividend reached $10 per
share per annum. See Letter from Fred and Charles Fisher to the General Motors Corpora-
tion, supra note 7. See also Letter from General Motors Corporation to Fred and Charles
Fisher (September 25, 1919), Gov’t Trial Ex. No. 427, Du Pont, 126 F. Supp. 235; Letter
from Pierre S. du Pont to Sir Henry McGowan (October 21, 1924), Defendants’ Trial Ex.
No. GM-32, Du Pont, 126 F. Supp. 235; and Agreement between Fisher Body Corporation
and Fred J. Fisher, supra note 14.
17
The Managers Securities Company was formed in November 1923 with 2,250,000
shares of GM common stock. See 1923 Annual Report of General Motors Corporation 9
(1924).
18
Charles Fisher also joined the GM executive committee but, contrary to Freeland’s ac-
count, remained an employee of Fisher Body to ‘‘spend most of his time in guiding Fisher
interests.’’ William A. Fisher became president, and Edward and Alfred Fisher remained as
executives of Fisher Body Corporation. Letter from Pierre S. du Pont to Sir Henry McGowan,
supra note 16.

to GM to build or purchase a number of assembly plants.19 These plants

were generally conveniently located near GM production facilities. As Ta-
ble 1 indicates, between 1919 and 1924 Fisher Body Corporation built or
purchased 14 assembly plants, 12 of which were located near GM produc-
tion facilities.20 During this period at least three of the new Fisher plants,
all located near GM production facilities, were financed by GM. These
included the St. Louis plant (Table 1, No. 3), built in 1922 near a GM
Chevrolet facility; the Flint plant (No. 11), built in 1923 near a GM Buick/
Chevrolet facility; and the Tarrytown, New York, plant (No. 14), built in
1924 near a GM Chevrolet facility.
Coase’s account of Fisher Body’s plant expansion under the 1919 supply
agreement during this period is somewhat inaccurate.21 But the conclusion
Coase reaches, that Fisher generally located its plants close to GM produc-
tion facilities during this early period, is accurate. Unfortunately, the infer-
ence Coase then draws from this evidence, that Fisher did not hold up GM,
is incorrect. Coase fails to distinguish this early period, when the Fisher-
GM contract was working and when Fisher was properly investing in plants
to serve GM production facilities, from the post-1924 period, when the con-
19
See Direct Testimony of Lawrence Fisher, at 1599–1600 (stenographer’s minutes), Du
Pont, 126 F. Supp. 235.
20
Fisher Body also built or purchased at least eight nonassembly plants involved in pro-
ducing hardware, glassware, and wood products during this period. See Arthur Pound, The
Turning Wheel 292, 298–99 (1934). See also 1923 Annual Report of General Motors Corpo-
ration, supra note 17, at 25; 1924 Annual Report of General Motors Corporation 27 (1925);
and 1926 Annual Report of General Motors Corporation 31 (1927).
21
Coase misses five of the 14 body plants Fisher built or acquired during 1919–24. This
is partially because he appears to rely entirely on Pound for his plant information, missing
three body plants not included in Pound—a body plant (No. 5) built in 1922 in Detroit near
Cadillac and Scripps Booth production (see White, supra note 8, at 55; 1919 Annual Report
of General Motors Corporation) and two plants (No. 12 and No. 13) built in 1923, one in
Tennessee and one in Ontario, Canada. The latter two plants are referenced in 1923 Annual
Report of General Motors Corporation, supra note 17; and 1924 Annual Report of General
Motors Corporation, supra note 20; as well as in General Motors Corporation, Fisher Body,
Its Contributions to the Automotive Industry (1924). In addition, Coase ignores two plants
added by Fisher during 1919 listed by Pound: the Fisher Body acquisition of its Fleetwood
Division (plant No. 1 (Table 1)) in Detroit in 1919 and the body plant (No. 2) added in
Cleveland in 1919. The Cleveland plant was not located near any GM facility. See Pound,
supra note 20, at 298–99. The existence of the Cleveland facility is confirmed in 1920 An-
nual Report of General Motors Corporation 7 (1921); and Poor & Moody’s Manual, Consoli-
dated Industrial Section (1919). Last, Coase, relying entirely on Pound, also incorrectly refers
to the Tarrytown plant as having been built in 1925. The Fisher Body Tarrytown facility is
listed in the 1924 Annual Report of General Motors Corporation, supra, and is also included
as a plant in operation in 1924 in General Motors Corporation, Fisher Body, Its Contributions
to the Automotive Industry, supra, at 6. Casadesus-Masanell and Spulber’s account of Fish-
er’s plant additions is much more inaccurate. They miss nine of the 16 plants listed in Table
1 (Nos. 1–5, 12–13, 15–16), including all the Fisher plant additions during 1919–22, two of
the eight 1923 plants, and, most important, as we shall later see, the 1926 Flint plant.

TABLE 1
Fisher Body Assembly Plant Additions (1919–26)
Year Location Terms of Acquisition Plant Size Near GM Division

1 1919 a Detroit a ⋅⋅⋅ 1,373,275 Cadillac/Scripps Booth d
2 1919 a Cleveland a ⋅⋅⋅ 1,525,217 ⋅⋅⋅
3 1922 a St. Louis a Financed by GMi 884,362 Chevrolet e
4 1922 a,c Pontiac, Mich.a,c Purchased from Beaudette c 1,393,004 GM Truck/Oakland (later Pontiac) e
5 1922c Detroit c ⋅⋅⋅ Cadillac/Scripps Booth d
6 1923a Lansing, Mich.a ⋅⋅⋅ 622,234 Olds Motor e
7 1923 a Cincinnati a ⋅⋅⋅ 182,167 Chevrolet e
8 1923 a Buffalo, N.Y.a ⋅⋅⋅ 150,692 Chevrolet e
9 1923a Oakland, Cal.a ⋅⋅⋅ 163,920 Oakland (later Pontiac) e
10 1923 a Janesville, Wis.a ⋅⋅⋅ 257,790 Chevrolet e
11 1923 a Flint, Mich.a Financed by GMi 266,443 Buick Motor/Chevrolet e
12 1923 e,h Memphis, Tenn.e,h ⋅⋅⋅ ⋅⋅⋅
13 1923 e,h Walkerville, Ontario e,h ⋅⋅⋅ All GM Models
14 1924 f Tarrytown, N.Y.a,h Financed by GMj 376,924 Chevrolet e
15 1925 a Fleetwood, Pa.a Purchased from Fleetwood Body b 230,465 ⋅⋅⋅
16 1926 a Flint, Mich.a Purchased from Durant Motors b 2,127,909 Buick Motor/Chevrolet g
Note.—Year: year in which Fisher Body acquired the plant, rather than the production start date when discrepancies exist. Terms of Acquisition: whether the
plant was purchased by Fisher Body or leased from GM, when information is available. Plant size: square feet of floor space as of June 1, 1933, from Arthur

Pound, The Turning Wheel 298–99 (1934). Near GM Division: make of GM vehicle assembled near the Fisher Body plant when applicable, from GM annual

reports.
a
Arthur Pound, The Turning Wheel 298–99 (1934).
b
Arthur Pound, The Turning Wheel 292–93 (1934).
c
Roger White, Body by Fisher: The Closed Car Revolution, 29 Automobile Q. 55 (August 1991).
d
1919 Annual Report of General Motors Corporation 7 (1920).
e
1923 Annual Report of General Motors Corporation 22, 25 (1924).
f
g
h
General Motors Corporation, Fisher Body, Its Contributions to the Automotive Industry 6 (1924).
i
Letter from F. G. Donner (vice president of GM) to Pierre S. du Pont (September 4, 1951).
j
Minutes of Executive Committee of General Motors (October 24, 1923).
tract was not working and when Fisher was not making the investments GM
required. As Table 1 indicates, after the GM-financed Tarrytown plant was
constructed in 1924, no new Fisher Body plants were built or acquired near
GM facilities until GM integrated with Fisher in 1926, after which GM pur-
chased the Durant plant in Flint. The only body assembly plant added by
Fisher Body during this period before vertical integration with GM was its
purchase in 1925 of a plant from Fleetwood Body in Fleetwood, Pennsylva-
nia, which was not near any GM auto plant.22
D. 1925–26: The Breakdown of the Fisher–General Motors Contract
During 1925–26 the demand by GM for closed Fisher bodies increased
dramatically. After growing modestly (about 50 percent) over the initial 5-
year period of the contract from 1919 to 1924, the number of vehicles pro-
duced by GM jumped 42 percent in 1925, and then another 48 percent in
1926.23 The industry share of sales that were closed bodies, which was 17
percent in 1920 and only 24 percent as late as 1923, simultaneously jumped
to 43 percent in 1924, 56 percent in 1925, and 72 percent in 1926,24 with
GM projecting in its 1924 annual report that 65 percent of its 1925 sales
would be closed bodies, and in its 1925 annual report that 75 percent of its
1926 sales would be closed bodies.25 The combination during 1925–26 of
very rapidly growing GM sales and the dramatic shift to closed bodies re-
sulted in an increase in Fisher closed body sales to GM during this 2-year
period of approximately 200 percent.
Coinciding with this dramatic increase in demand by GM for Fisher
product during 1925–26, the GM–Fisher Body relationship began to un-
ravel.26 Alfred Sloan summarizes the situation in the following way: ‘‘In
22
Pound, supra note 20, at 292–93.
23
General Motors production was 391,738 vehicles in 1919, 587,341 in 1924, 835,902 in
1925, and 1,234,850 in 1926. See Alfred P. Sloan, Jr., My Years with General Motors 214
(1964).
24
Id. at 152.
25
1924 Annual Report of General Motors Corporation, supra note 20, at 12; 1925 Annual
Report of General Motors Corporation 10 (1926). I am grateful to Freeland for pointing out
that my previous reference to GM closed-body sales share of 65 percent in 1924 should have
referred to a 1924 projection of a 1925 sales share.
26
Exactly when the contract breakdown began is unclear. However, contrary to Freeland’s
assertion that the contract difficulties surrounded the extension of the Fisher’s employment
agreements in 1924, the overwhelming weight of the available evidence indicates that sig-
nificant difficulties in the operation of the body supply contract, in particular the Flint plant
disagreement, arose after the renegotiation of the Fisher brothers’ employment and compen-
sation arrangements in 1924. Freeland, supra note 5, at 44 n.34, recognizes that it is unclear
exactly when GM decided it was necessary to purchase the remainder of Fisher Body and
that much of the evidence indicates that this did not occur until 1925. But he assumes that
the contract breakdown and vertical integration decision was made in 1924 so he can tie it to
the employment agreement renegotiation. Although Freeland claims to make this assumption

the intervening years between 1919 and 1924, the industry had moved for-
ward to the point where it was almost an exclusively closed body as com-
pared to the open bodies which was the practice before 1919. The contract
relationship between Fisher Body Corporation and General Motors Corpo-
ration being cost plus and profit, it became burdensome.’’ 27
Sloan describes the burdensome nature of the Fisher Body supply con-
tract in two distinct ways. One problem, Sloan testifies, was related to the
increased demand by GM for bodies. In particular, ‘‘[t]he increased turn-
over reflected in return on capital resulted in cost and selling prices that
were no longer competitive.’’ 28 A second problem, Sloan testifies, is that
‘‘the Fisher brothers, who were really operating the Fisher Body Company
in those times, rather questioned the desirability of their putting up large
amounts of capital to establish these assembly plants in conjunction with
the GM assembly plants.’’ 29 He continues, ‘‘[W]here we had a chassis as-
sembly plant, we had to have a Fisher Body assembly plant, but the Fisher
Body Corporation was unwilling to put in an investment in these assembly
plants. That handicapped us considerably.’’ 30
As a consequence of these problems, Sloan testifies, the acquisition of
Fisher Body in 1926 was ‘‘not a question of anything but a must. We just
had to have that forty percent interest. It was unrealistic to think that an
operation of the magnitude of General Motors could continue an operating
arrangement such as I testified to here, and buy a substantial part of its bod-
ies or all of its closed bodies under such circumstances. We had to have an
integrated operation. . . . the acquisition of that forty percent in 1926 was
a must. We just had to have it irrespective of any other considerations.’’ 31
arguendo (because of the mistaken statement in Klein, Crawford, & Alchian, supra note 2,
at 310, that the contract became intolerable to GM in 1924, rather than in 1925), his argument
in fact turns on this assumption. In addition to Freeland’s numerous references (in n.34) to
the exact timing of GM’s acquisition decision, which are largely consistent with a 1925 date,
we should add Sloan’s statement that the earliest discussions held in the GM executive com-
mittee on whether to bring Fisher body production into GM occurred on February 3, 1925.
See Sloan, supra note 25, at 161. Coase’s and Casadesus-Masanell and Spulber’s references
to the fact that GM had discussed the idea of a possible merger or ‘‘closer association’’ with
Fisher earlier is not surprising. One would expect vertical integration to be discussed as an
alternative in any relationship that warranted a 10-year exclusive dealing contract, but these
earlier discussions did not deal with GM’s urgent economic necessity for vertical integration,
as did the critical discussions in 1925.
27
Direct Testimony of Alfred P. Sloan, Jr., at 2911, Du Pont, 126 F. Supp. 235.
28
Id. Similar testimony is repeated by Sloan in his Deposition Testimony, at 188, Du Pont,
126 F. Supp. 235.
29
Deposition Testimony of Alfred P. Sloan, Jr., at 190, Du Pont, 126 F. Supp. 235.
30
31
Id.

One cannot examine the record without concluding that from GM’s per-
spective the contract with Fisher Body was not working during 1925–26
and that this motivated vertical integration.32 Coase brushes over this testi-
monial evidence by describing the situation in 1925 as one where GM was
‘‘dissatisfied with the 1919 arrangement.’’ 33 In fact, GM was much more
than merely ‘‘dissatisfied.’’ Sloan’s testimony clearly describes what he
perceives as the disastrous consequences of a ‘‘burdensome’’ contract that
led to noncompetitive prices and inadequate investments. Moreover, Coase
does not explain why GM was ‘‘dissatisfied with the 1919 arrangement.’’
He only vaguely notes that Fisher ‘‘paid less attention to the needs of Gen-
eral Motors than General Motors would have liked.’’ 34 Coase tells us nei-
ther in what ways Fisher did not consider the needs of GM nor exactly how
the contractual arrangement failed in these respects.
Examining the two problems that Sloan says existed in the Fisher-GM
contractual arrangement provides economic insight into the nature of the
contract breakdown. First of all, Sloan suggests that the rapid unexpected
increase in demand for Fisher bodies (‘‘increased turnover’’) led to greater
than competitive costs and prices because this permitted Fisher to earn a
greater than competitive return on capital. The demand increase appears to
have led to an increase in the ratio of Fisher Body’s sales (and, hence, non-
capital costs) to its required capital investment. Therefore, according to
Sloan, the contractually fixed percentage upcharge on noncapital costs (17.6
percent) resulted in prices that were too high because it implied a margin
that was more than sufficient to provide a normal rate of return on capital.
This increase in Fisher’s sales-to-capital ratio may have been due solely
to the realization of large economies of scale in capital (for example, dies
that could be used more intensively as sales increased) caused by the very
large increase in sales that was unrecognized at the initial time of con-
tracting when the 17.6 percent upcharge was set. But if this problem of too
high a rate of return earned by Fisher on capital was caused entirely by the
unexpected realization of economies of scale in capital, it might conceiv-
ably have been solved contractually, at the very least going forward (per-
32
Casadesus-Masanell and Spulber incredibly claim (supra note 6, at 79) that Sloan’s tes-
timony refers solely to pricing flexibility, not to high prices, completely ignoring Sloan’s
statement that the contract ‘‘resulted in selling prices that were no longer competitive.’’ Their
claim is also internally inconsistent with their incorrect assertion (id.) that ‘‘General Motors
was able to update pricing provisions because it had a controlling interest in Fisher Body
dating back to 1919.’’ (See Section IIB infra for documentation that GM did not obtain con-
trol of Fisher Body in 1919.)
33
Coase, supra note 4, at 24.
34
Id.

haps after a side payment was made by GM to Fisher) by the use of a sim-
ple price adjustment contract term based on Fisher sales.
However, it is clear from the record that much more was involved with
GM’s dissatisfaction than merely a failure of the contract formula to ac-
count for the unexpectedly rapid sales growth. Sloan testifies that GM was
also upset about Fisher’s refusal to make the necessary capital investments
in new body plants in conjunction with GM assembly plant expansions.
Fisher’s reluctance to make the necessary investments in capacity to handle
GM’s increased requirements resulted in GM experiencing body shortages
that forced it to reduce its scheduled production during 1925.35
E. Fisher’s Flint Plant Holdup of General Motors

What was particularly troublesome to GM in 1925 was Fisher’s refusal
to make the investment in plant and equipment necessary to move Fisher’s
production of Buick bodies from Detroit to a site near the GM Buick as-
sembly plant in Flint. Fisher insisted on continuing to produce Buick bod-
ies in its Detroit plant, where (beginning around 1924) it was also supply-
ing closed bodies for the Chrysler Corporation.36 For GM this involved
increased shipping costs, including the extra costs of transporting the bodies
57 miles from Detroit to Flint and the extra labor costs involved in loading
and unloading the bodies, on which Fisher could add 17.6 percent.37
Coase acknowledges that a problem existed with regard to the Flint plant
in 1925 but states that this was only one plant out of many plants that were
built or acquired by Fisher during the period before vertical integration in
1926. This ignores the fact that the earlier plants were built before GM’s
large demand increase, when the contract was functioning as intended.
Moreover, the Flint plant should not be considered as merely one plant out
of many. The plant became the largest Fisher Body facility and, ultimately,
the largest auto body plant in the world.38
35
See 53 (12) Automotive Industries 476 (1925). Fisher’s failure to make adequate invest-
ments does not appear to be due to an inadequacy of investment funds. In fact, Fisher was
making investments in body capacity for other companies such as Chrysler at the same time.
See Fisher Body Co. Starts Addition to Cost $350,000, 53 (9) Automotive Industries 358
(1925).
36
Direct Testimony of Lawrence Fisher, at 1614–17 (stenographer’s minutes), Du Pont,
126 F. Supp. 235.
37
This does not mean that Fisher could have legally used its GM contract to put a plant
in, say, Alaska to collect additional transportation and labor costs. Contract law, even in the
1920s, likely would not have enforced such a clear Fisher holdup. But the courts then and
now would be very unlikely to second-guess Fisher’s decision to expand body production in
Detroit, rather than build a new plant in Flint, to serve GM’s Buick demand.
38
Pound, supra note 20, at 293.

Coase also dismisses the Flint plant episode as merely a disagreement

over financing.39 Presumably, this is because Sloan describes the situation
in terms of Fisher refusing to put up the large amounts of capital required
for GM’s expansion.40 But a disagreement over financing would not likely
have produced a complete impasse over the Flint plant. It is unlikely Fisher
merely was dragging its feet to get GM to finance construction. General
Motors could have financed the Flint plant, as it had done for at least three
other plants during 1922–24, by providing a loan to Fisher for the capital
costs. If Fisher had wanted to build the Flint plant under these GM finance
terms, there is no reason it would not have been built, and the Buick body
supply problems would have been solved. But a GM-financed solution to
the Flint plant would have implied increased capital costs to Fisher that
were not reimbursable under the terms of the 1919 body supply contract.
And Fisher would have owned the Flint plant, as it owned the other plants
financed by GM, and would have been obligated to continue making fi-
nancing payments to GM even after expiration of the body supply contract
in 1929.
This points up a major problem associated with the large unexpected in-
crease in demand and the required specific capital investments that devel-
oped late in the life of the contract. Fisher’s investment in a plant specific
to GM, located some distance from other automobile manufacturers, with
only 4 years to run in the body supply contractual agreement (or perhaps
only 3 years to run after completion of the plant), would have created a
potential for GM to hold up Fisher at the expiration of the contract.
However, it is unlikely that GM was trying to hold up Fisher with this
demand for new Fisher investments. Fisher obviously would be reluctant to
make such investments. It makes no economic sense to explain GM’s be-
havior as an attempt to deceive a naive Fisher Body. Instead, this demand
by GM should be thought of as the start of the required contract negotiation
process. But rather than merely ask GM for an extension of the contract
before making new large investments in Flint, Fisher used its existing con-
tract with GM and, in particular, the fact that GM was exclusively tied to
Fisher for another 4 years by a cost-plus contract to increase its renegotia-
tion bargaining power by continuing to supply Buick bodies from its De-
troit facility. Fisher thereby avoided the extra capital costs of the Flint plant
while imposing costs on GM in the form of added transportation and labor
costs upon which GM was contractually obligated to pay Fisher an up-
charge. Fisher was, in effect, demanding a large side payment before mak-
ing the required contractual adjustments, and GM’s purchase of the remain-
39
40

der of Fisher Body was the form in which this side payment ultimately
occurred.
F. Freeland’s Claim That the Flint Plant Disagreement

Did Not Involve a Fisher Holdup of General Motors
Freeland, contrary to Coase, does not minimize the problem of Fisher’s
failure to invest in properly located plant capacity and, in particular, recog-
nizes that Fisher’s resistance to building a plant in Flint in 1925 was a pri-
mary motivation for GM’s decision to purchase the remainder of Fisher
Body. But Freeland suggests that Fisher’s reluctance to establish a new
plant in Flint and its behavior that followed were economically understand-
able. Freeland notes that ‘‘Fisher undoubtedly preferred to add operations
in Detroit rather than to build an entirely new facility less than 60 miles
away.’’ 41 However, a plant at Flint was not an unreasonable desire for GM.
Once vertical integration occurred in 1926, GM made a large investment in
a Flint facility and eventually closed the Detroit operation. A Flint plant
investment clearly would have maximized the joint profit of GM and
Fisher. While it was reasonable for Fisher not to want to make a new large
GM-specific investment without an additional long-term contractual com-
mitment, Fisher’s behavior took advantage of the existing contractual ar-
rangement to disadvantage GM substantially.
Freeland also notes that it was logical for Fisher to want to keep Buick
production in Detroit because ‘‘Detroit was one area in which Fisher had
important customers besides GM.’’ 42 This is just a statement of why it was
in Fisher’s narrow economic interest not to make the desired relationship-
specific investments in a plant located close to GM’s facility in Flint. By
keeping Buick production in Detroit, Fisher was able to share its GM over-
head costs with Chrysler production and, by making its investment less spe-
cific, to protect against a possible GM holdup at the expiration of the con-
tract. But, by refusing to make the large capital investments desired by GM
in a new plant at Flint, Fisher was also improving its bargaining position
by adopting an inefficient (more labor- and transportation-intensive and less
capital-intensive) production technology that increased GM’s costs and arti-
ficially increased its own profits.43
41
Freeland, supra note 5, at 51.
42
Id.
43
Id. at n.61, also uses the fact that the Flint plant was planned to produce Buicks, rather
than GM’s largest selling product, Chevrolets, as evidence that the Flint plant location dis-
agreement did not involve a holdup. Chevrolets, not Buicks, he claims would have been the
‘‘most lucrative target.’’ The sales of Chevrolet were indeed greater than the sales of Buick,
but at this time GM was producing Chevrolets in four separate plant locations (St. Louis,
Buffalo, Tarrytown, and Janesville), while Buicks were being produced only in Detroit. See

Freeland presents three additional arguments that, he claims, convinc-

ingly demonstrate that the 1925 Flint plant location problem did not involve
Fisher taking advantage of the imperfect 1919 contract to hold up GM. All
three arguments are incorrect. Freeland’s first argument is that a Fisher
holdup of GM never occurred because the 1919 body supply contract was
likely not in effect at the time of the Flint plant disagreement. He sup-
ports this claim by referring to the ‘‘foremost scholarly account’’ of Alfred
Chandler and Stephen Salsbury, which states that the 1919 cost-plus con-
tract, originally scheduled to run to 1929, was renegotiated in 1924.44 How-
ever, the supporting documents cited by Chandler and Salsbury refer only
to the 1924 renegotiation of the original 1919 employment contracts of the
Fisher brothers. These documents provide absolutely no evidence for Chan-
dler and Salsbury’s claim that the body supply contract also was renegoti-
ated at this time.45
In fact, a letter written by the board of directors of Fisher Body Corpo-
ration to its shareholders in May 1926 in connection with the proposed
merger with GM states unambiguously that the 1919 body supply contract
was still in effect in 1926.46 This is also consistent with the fact that
1926 Annual Report of General Motors Corporation, supra note 20. Moreover, it was the
Buick plant investment decision that came up at the time that the contract broke down in
1925.
44
Freeland, supra note 5, at 47, citing Alfred D. Chandler, Jr., & Stephen Salsbury, Pierre
S. du Pont and the Making of the Modern Corporation 576 (1971). Casadesus-Masanell and
Spulber also refer to Chandler and Salsbury for this point.
45
Chandler and Salsbury rely on three primary documents: (1) letter from Pierre S. du
Pont to Arthur Bishop (October 14, 1924) (on file with the Pierre S. du Pont Papers, Hagley
Museum and Library, Wilmington, Del.) [this archive is hereinafter referred to as du Pont
Papers]; (2) letter from Harry McGowan to Pierre S. du Pont (November 7, 1924), Defen-
dants’ Trial Ex. No. GM-33, Du Pont, 126 F. Supp. 235; and (3) letter from Pierre S. du
Pont to General Motors Finance Committee (January 26, 1925), du Pont Papers. All three of
these documents refer only to the employment contract renegotiated in 1924 and do not make
any mention of pricing arrangements and, in particular, the separate cost-plus body supply
contract, which had a 10-year term. Freeland prefaces his discussion of Chandler and Sals-
bury with the statement ‘‘If this claim is correct’’ (Freeland, supra note 5, at 45), apparently
recognizing the lack of support in the record for the Chandler and Salsbury conclusion. But
he then misleadingly refers to the Chandler and Salsbury conclusion numerous times in his
paper as if it were correct and includes a detailed description of how Fisher body pricing
reverted in 1924 to a formula based on operating value, overhead allocation, and a return on
invested capital, none of which is specifically mentioned by Chandler and Salsbury.
46
‘‘In 1919 General Motors acquired a sixty per cent (60%) interest in the common stock
of Fisher Body and at the same time entered into a ten-year contract for its automobile body
requirements. As you are aware, this contract has been exceedingly profitable to Fisher Body,
and at the present time about 90% of its business consists of bodies made for General Motors.
. . . As the contract made with General Motors in 1919 has but a relatively short term re-
maining, your officers and directors have given serious thought to the future prospects of
Fisher Body. In 1929 a new contract must be negotiated, or General Motors will be free
either to build its own bodies or purchase them elsewhere.’’ Letter from Board of Directors

GM officials during the 1926 negotiation did not want Fisher to obtain
the ‘‘unfair’’ benefits of the contractual arrangement going forward47 and
with Sloan’s testimony, reproduced above, that the ‘‘burdensome’’ cost-
plus contract was a motivation for GM’s integration with Fisher in 1926.48
Freeland’s second reason for why a holdup did not occur in 1925 is that,
even if the body supply contract remained in place, the voting trust expired
October 1, 1924. Therefore, after that date GM was free to vote its 60 per-
cent interest in Fisher Body and had effective control of Fisher Body.49
However, contrary to Freeland, GM clearly did not have control of Fisher
Body until its complete acquisition of Fisher in 1926. If GM fully con-
trolled the relationship after the expiration of the voting trust agreement in
1924, it certainly would not have continued the ‘‘burdensome’’ Fisher-GM
contract. Sloan refers to GM’s lack of control and, in particular, its inability
to rescind the Fisher contract when testifying that ‘‘we could not adjust be-
cause we always had to respect the forty percent outstanding interests.’’ 50
He also said that ‘‘we were bound by a contract in which the minority inter-
est was outstanding, which we had to respect.’’ 51
In addition to Sloan’s testimony that GM was ‘‘bound by a contract’’ in
which Fisher’s 40 percent interest remained outstanding and had to be hon-
of Fisher Body Corporation to the Stockholders of Fisher Body Corporation (May 17, 1926),
Gov’t Trial Ex. No. 506, Du Pont, 126 F. Supp. 235.
47
Correspondence among GM officials states that the value of Fisher Body should be de-
termined independent of the favorable contract, or, at the very least, a compromise should
be struck. ‘‘I am absolutely against making a deal other than on the basis of looking forward
rather than backward. I feel as we go on our position becomes strengthened [presumably
because the contract was getting closer to expiration in 1929], but irrespective of our short-
comings in the past, which of course affects our present market situation to some extent, it
has nothing to do with the future and this perhaps deals with the future to a very material
degree. Irrespective of all this, of course I recognize the market position in a thing of this
kind necessitates some sort of a compromise. Whatever Fred [Fisher] may have in mind, of
course I do not know, but I fear that he will feel that the market should be equalized to its
full present relation. If that is insisted upon, I do not think we should go ahead and that is
the reason why I feel that that is the vital point on which his position should be determined.’’
Letter from Alfred Sloan to J. J. Raskob (an official of GM) (February 13, 1926), Defendants’
Trial Ex. No. GM-34, Du Pont, 126 F. Supp. 235.
48
Freeland, supra note 5, at 48 n.44, thanks Coase for pointing out to him that Sloan’s
testimony is ‘‘subtly ambiguous about whether the cost-plus provisions were in effect after
1924.’’ Neither author informs us about the nature of the ambiguity. The alleged ambiguity
may be based on the fact that Sloan describes the ‘‘burdensome’’ cost-plus contract after
describing the industry growth of closed bodies during 1919–24. See Direct Testimony of
Alfred P. Sloan, Jr., at 2911, Du Pont, 126 F. Supp. 235. If so, this is a contrived ambiguity.
Sloan’s answer is in response to a question regarding the reasons for GM’s purchase in 1926
of the remaining 40 percent of Fisher Body.
49
Freeland, supra note 5 at 48.
50
51

ored, Lawrence Fisher explicitly testified that the management of Fisher

Body maintained operating control of Fisher Body after the expiration of
the voting trust in 1924.52 The evidence is unambiguous that GM did not
have the power to abrogate its body supply contract with Fisher during
1925–26 or to determine Fisher Body investment decisions or plant loca-
tions, in spite of its 60 percent ownership share. Perhaps it was because,
under its ownership agreement with Fisher, GM controlled only 50 percent
of the board of directors and only two-sevenths of the executive committee
of Fisher Body.53 Or perhaps GM would have faced litigation by the minor-
ity shareholders of Fisher Body if it unilaterally abrogated the contract. In
any event, it is clear from the events during both 1925 and the 1926 negoti-
ation over the terms of vertical integration that the GM–Fisher Body cost-
plus exclusive dealing contract remained in effect in 1926 and was proving
especially burdensome to GM.54
Freeland’s third reason why it is unlikely Fisher engaged in a holdup of
GM is that once the Fisher brothers were more fully brought into GM in
1924, the financial incentives of the Fisher brothers became aligned with
those of GM.55 However, although Freeland correctly notes that after 1924
the Fisher brothers’ compensation was provided primarily by a stake in the
GM stock incentive plan, the Managers Securities Company, the Fisher
brothers’ collective 15 percent share in this plan represented less than 2 per-
cent of the total outstanding shares of GM common stock.56 In contrast, the
52
Direct Testimony of Lawrence Fisher, at 1559–60, Du Pont, 126 F. Supp. 235.
53
The board of directors of Fisher Body consisted of 14 members, with seven members
nominated by the finance committee of the GM Corporation and the other seven members
nominated by Fred Fisher and Louis Mendelssohn. The executive committee of Fisher Body,
which had complete charge of the operations of the corporation except finances, consisted of
seven members, two of whom were chosen from the representatives of the board of the GM
Corporation, and the balance from the members of the board nominated by Fisher and Men-
delssohn. See Letter from Fred and Charles Fisher to General Motors, supra note 7.
54
Coase also makes a control-type argument to refute the possibility of a Fisher holdup,
claiming that Fisher could not have built inefficient plants because ‘‘to the extent that Fisher
Body was paying the capital costs, it needs to be remembered that General Motors nominated
a majority of the members of the finance committee of Fisher Body, which would have had
to approve such expenditures.’’ Coase, supra note 4 at 30. However, Fisher was only decid-
ing to continue production at Detroit. The finance committee of Fisher Body could not have
made the unilateral decision to build a plant in Flint. The actions of the finance committee
likely dealt with approval of investment decisions made by the board of directors, which GM
did not control. See Letter from Fred and Charles Fisher to General Motors Corporation su-
pra note 7.
55
Freeland, supra note 5, at 46–47.
56
The Fishers’ share of the plan is based on Letter from Pierre S. du Pont to Arthur
Bishop, supra note 45; Managers Securities Company, Interrogatory 7(a) and 7(b), Gov’t
Trial Ex. No. 259, Du Pont, 126 F. Supp. 235. In 1924 the number of shares of GM common
stock outstanding was reduced from 20,646,397 (in 1923) to 5,161,599 (see 1924 Annual
Report of General Motors Corporation, supra note 20), and the holdings of the Managers

Fisher brothers’ ownership interest in Fisher Body Corporation was about

20 percent.57 Although the Fisher brothers did not want GM to fail, the fact
that the Fisher brothers’ interest in Fisher Body Corporation was more than
10 times greater than their interest in GM Corporation implies that they
could make more money if they transferred income from the latter to the
former.58
On July 1, 1926, 1 day after the GM acquisition of Fisher Body was fi-
nalized, GM announced a $40 million expansion program for 1927.59 This
included $5 million authorized to create body-building facilities in Flint,
which was accomplished by the purchase of the Durant Motors plant in
Flint in 1926,60 and $8 million and $5 million to be used to provide addi-
tional capacity for the Chevrolet division and Oakland division, respec-
tively.61 The original Fisher plant in Detroit subsequently shut down, and
the new plant that was developed in Flint became the largest Fisher Body
plant.62
Securities Company were reduced from 2,250,000 shares of GM common stock to 562,500
shares. See Managers Receive Dividend Benefits, Wall St. J., May 15, 1926. Therefore, the
Fisher brothers’ ownership interest in GM was about 1.6 percent (0.15(562,500)/5,161,599
⫽ 0.016).
57
The Fisher brothers owned approximately 20 percent of Fisher Body Corporation in Oc-
tober 1922. I have not been able to locate any evidence of the Fisher brothers’ share holdings
in Fisher Body during the 1924–26 time period and assume that the Fisher brothers’ interest
in Fisher Body Corporation did not change substantially from the fall of 1922 to the fall of
1924. See Letter from Pierre S. du Pont to Lammot du Pont (October 31, 1922), Gov’t Trial
Ex. No. 435, Du Pont, 126 F. Supp. 235.
58
Distinct from Fisher’s financial incentives, Coase argues, GM would not have brought
the Fisher brothers more fully into GM and appointed them to various senior positions of
authority within the GM organization if the Fishers were engaging in a holdup. But, once
again, Coase is ignoring the timing of these actions. In particular, the Fishers were appointed
before the 1925–26 disagreement, when the contract was functioning well. Specifically, Fred
Fisher was made a director of GM in 1921, was appointed a member of the executive com-
mittee of GM in 1922, and was appointed to the finance committee in 1924 after the renegoti-
ation of his employment relationship. Charles and Lawrence Fisher also joined the board of
directors and the executive committee of GM in 1924 in connection with the renegotiation
of their employment relationship. In explaining why the Fishers maintained these positions
throughout the hold-up period in 1925–26, it is important to distinguish between appointing
someone to a senior position, which I agree with Coase is unlikely to occur if a holdup is
taking place, and terminating someone (assuming this would have been legally possible in
the time frame involved) given that negotiation was ongoing to resolve the disputed issues
and that a complete break in relations had not occurred.
59
GMC Divisions Get $40,000,000 for 1927 Expansion Program, 55 Automotive Indus-
tries 30 (1926).
60
Pound, supra note 20, at 293; see also New Fisher Plant Will Start Work Nov. 1, 55
Automotive Industries 710 (1926)
61
GMC Divisions Get $40,000,000 for 1927 Expansion Program, supra note 59, at
30.
62
Pound, supra note 20, at 293, 298–99.

G. Defining Hold-Up Behavior: 1925–26 versus 1933–34

Although my statement of the facts of the Fisher Body–GM case is la-
beled ‘‘erroneous’’ by Coase,63 ‘‘grossly inaccurate and misleading’’ by
Freeland,64 and a ‘‘fable’’ by Casadesus-Masanell and Spulber, my descrip-
tion of the relevant events fundamentally agrees with Coase’s and Free-
land’s descriptions.65 In particular, both Coase and Freeland agree that prob-
lems existed during 1925–26 regarding the Fishers’ willingness to finance
expansion and to locate a plant in Flint. Freeland further agrees that these
problems were a major motivation for GM’s vertical integration with Fisher
Body in 1926, and Coase notes that this is consistent with what he reports
he was told by GM executives during his visit to the United States in 1931–
32 regarding the reason for vertical integration.
Coase’s and Freeland’s disagreements with my description of events pri-
marily involve my interpretation of these agreed upon facts. In particular,
neither Coase nor Freeland want to label the problems experienced during
1925–26 as a holdup. In contrast, Freeland describes as a holdup the Fisher
brothers’ demand for increased compensation in 1933–34, after vertical in-
tegration already had occurred.66 Comparing these two episodes provides a
helpful economic framework in which to formulate a useful definition of
hold-up behavior. As we shall see, the Fisher brothers’ investment and pric-
ing behavior in 1925–26, which led to the breakdown of the Fisher-GM
contract and to vertical integration, should more properly be classified as
a holdup than the Fisher brothers’ employment contract renegotiation in
1933–34.
Freeland describes the 1933–34 episode as a demand by the Fisher broth-
ers for increased compensation if they were to continue working for Fisher
Body (now fully owned by GM). Specifically, the Fishers demanded that
GM grant them options on 200,000 shares of GM common stock at an exer-
cise price of the then prevailing $40 market price. In response to this threat
by the Fisher brothers to collectively leave Fisher Body, GM eventually
agreed to grant options on a total of 100,000 shares of GM stock, with one-
third of the shares exercisable after each of 3 years of employment.67
Freeland describes this demand by the Fishers for additional compensa-
tion as an attempt to force GM, after having purchased Fisher Body at a
63
64
65
As noted above (supra note 21), Casadesus-Masanell and Spulber inexplicably ignore
the Flint plant episode entirely in their analysis.
66
67
Letter from William du Pont to Lammot du Pont Copeland (May 4, 1934), du Pont
Papers.

substantial premium in 1926, to ‘‘pay yet again’’ in 1934.68 This is a gross

overstatement. The options granted to the Fishers in 1934 had a market
value of about $1 million.69 In contrast, the Fishers received $65 million for
their 20 percent interest in Fisher Body in 1926, or a premium of more than
$36 million over market value.70 Clearly, GM was not ‘‘paying twice’’ for
the company. However, the question remains whether the demand by the
Fishers for additional compensation was a holdup.
At the time the Fisher brothers made their demand for stock options, a
formal employment contract did not exist between GM and the Fisher
brothers. All of the Fisher brothers were employees of GM, but there was
no long-term contractual commitment by the Fishers to manage Fisher
Body or by GM to guarantee future employment. Indeed, the testimony of
Lawrence Fisher indicates that an explicit employment contract did not ex-
ist after vertical integration occurred in 1926.71 The Fisher brothers appear
to have been operating under employment-at-will arrangements. Therefore,
the threat by the Fishers to leave GM did not involve the violation of any
explicit contractual agreement on their part. If a holdup is defined as an
attempt by one transacting party to renege on an explicit, agreed upon con-
tract, the Fisher brothers were not holding up GM when they threatened to
leave in 1934.
Reneging on an explicit contract is too narrow a view of holdups, how-
ever. A more useful definition of hold-up behavior involves one party tak-
ing advantage of the fact that its transacting partner has made specific in-
vestments and that the contract governing the relationship is incomplete to
appropriate the quasi-rents from the relationship-specific investments. I dis-
68
69
Id. at 58 incorrectly describes the Fishers’ initial request for options on 200,000 shares
at the then prevailing market price of $40 as an ‘‘$8 million investment.’’ However, the op-
tions simply would have provided the Fishers with the right to purchase shares at a future
date at the predetermined price of $40. Using the Black-Scholes option pricing formula and
assuming (perhaps unrealistically) that the future volatility of GM stock can be measured by
the extremely high level of volatility of the previous year’s daily closing prices, the approxi-
mate value on May 4, 1934, of the options eventually granted to the Fisher brothers was
about $1.1 million. (This calculation uses an extremely low risk-free interest rate in 1934 of
less than one-tenth of 1 percent (0.076 percent) obtained from the Center for Research in
Security Prices at the University of Chicago.)
70
The value of the net assets of Fisher Body Corporation was approximately $143 million
in 1926. The Fisher brothers’ portion (20 percent) of this amount was equal to $28.6 million.
The market value of the GM stock used to acquire the remaining 40 percent of Fisher Body
that GM did not already own was about $130 million, and, therefore, the Fisher brothers
received approximately $65 million for their $28.6 million interest. See Seltzer, supra note
11, at 218–19.
71
Direct Testimony of Lawrence Fisher, at 1565–66 (stenographer’s minutes), Du Pont,
126 F. Supp. 235.

cuss in the next section why transactors make specific investments that put
themselves into this position where they can be held up, but the important
thing to recognize here is that hold-up behavior need not involve the viola-
tion of the explicit written terms of the parties’ contractual arrangement.
Under this definition of a holdup, the Fishers may have been holding up
GM when they jointly demanded renegotiation of their employment rela-
tionship in 1933, if they were taking advantage of the specific investments
made by GM in Fisher Body that depended on the continued management
of the Fisher brothers.
But this broader, more useful, definition of a holdup—based on the ap-
propriation of relationship-specific investments—would imply that Fisher
Body also was engaging in hold-up behavior during 1925–26, when the
Fishers used the imperfect cost-plus body supply contract with GM to
‘‘overcharge’’ for bodies and to refuse to make the required investments in
new plant capacity. The fundamental economic behavior in both examples
is identical. They both involve Fisher taking advantage of GM-specific in-
vestments and the fact that the court will enforce the imperfect explicit con-
tract terms that govern an economic relationship rather than the underlying
contractual understanding.
With regard to the Fisher body supply holdup in 1925–26, the court pre-
sumably would have enforced the imperfect long-term, exclusive dealing
contract that locked in GM, thereby permitting Fisher to engage in a holdup
by not making the desired investments and by charging GM relatively high
body prices. With regard to the Fisher labor supply holdup in 1933–34, the
court presumably would have enforced the imperfect contract that governed
the contractual understanding between the Fishers and GM (in particular,
the court would have recognized the absence of any long-term employment
commitment between the parties), thereby permitting the Fisher brothers to
take advantage of any Fisher-specific investments made by GM by threaten-
ing to leave if they did not receive an additional payment from GM. In both
cases the Fishers were taking advantage of the imperfect contract that gov-
erned a postcontract bilateral monopoly (created by a long-term exclusive
dealing contract in the 1925–26 case and by the Fisher-specific reliance in-
vestments of GM in the 1933–34 case) to hold up their transacting partner.
However, while the Fishers’ behavior during 1925–26 clearly involved
the appropriation of relationship-specific quasi-rents, the Fishers’ demand
for stock options in 1933–34 may be explainable on other terms. As docu-
mented by Freeland, the Fishers’ behavior during 1933–34 may have been
caused by the fact that the depression forced them to liquidate their
500,000 shares of GM stock in 1931.72 This left them with no holdings in
72

GM outside of their participation in the stock incentive plan. Since the

Fishers were being compensated predominantly by a return on their GM
stock, some renegotiation of the employment agreement was required if
they were to have the proper incentive to continue working for GM and
managing Fisher Body. This is analogous to the readjustments that com-
monly occur in the exercise prices on executive stock options in order to
keep managers’ performance incentives high when the general stock mar-
ket falls. For these reasons it is not clear that the Fishers were holding up
GM during 1933–34.73
Freeland may label the Fishers’ 1933–34 demand for stock options as a
holdup because a GM executive described the Fisher demand for increased
compensation in 1934 as ‘‘almost a ‘hold up.’ ’’74 But it is less obvious that
the Fishers’ behavior during 1933–34 involved a holdup, in the sense of a
transactor using an imperfectly specified contract to appropriate the quasi-
rents from relationship-specific investments, than that the Fishers’ behavior
during 1925–26 involved such a holdup. The GM demand in 1925 that
large additional specific investments be made by Fisher late in the contract
term no doubt required some form of contractual adjustment (at the very
least a contract extension). However, the Fishers’ failure to build the body
plant at Flint that GM required for efficient production and, instead, their
decision to increase their short-run profit by taking advantage of the ex-
isting imperfect contract clearly involved appropriation of relationship-
specific quasi-rents.
III. Why the Fisher Body Holdup of General Motors Occurred

An obvious question is why GM entered into a contractual agreement
that placed it in a position where it could be held up by Fisher. As I have
explained in detail elsewhere,75 it does not make sense to assume that Fisher
deceived GM into entering the long-term cost-plus contract. Relying on the
ability of transactors to take advantage of their transacting partners is a
highly unsatisfactory, usually untestable, way to explain holdups. General
73
Freeland arbitrarily assumes that the Fishers were motivated in 1933 by the possession
of inside information that GM stock was undervalued in the market and that (contrary to the
usual economic assumption that individuals at all times are wealth maximizing) they were
trying to recoup the wealth (estimated at $400 million) they had lost in the depression (see
Freeland, supra note 5, at 57 n.85). However, if the Fishers possessed such inside informa-
tion, they could have earned a significant return without demanding a change in their employ-
ment terms.
74
Freeland, supra note 5, at 58, citing Letter from William du Pont to Lammot du Pont
Copeland, supra note 67.
75
Benjamin Klein, Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Rela-
tionships, 34 Econ. Inquiry 444 (1996).

Motors and Fisher Body were two large, sophisticated business firms that
likely were fully cognizant of the malincentive problems inherent in the im-
perfect contract they were entering. General Motors and Fisher adopted the
contract in spite of these potential hold-up problems because they expected
it to function satisfactorily in combination with a self-enforcement mecha-
nism.
A self-enforcement mechanism assures performance by threatening ter-
mination of the relationship.76 Such a mechanism is what initially prevented
Fisher from taking advantage of the contract. Fisher always had the ability
to exploit the imperfect body supply contract, as it started to do in 1925,
but if Fisher took advantage of the contract before 1925, it had more to lose
from GM’s nonrenewal of the agreement than it had to gain. That is why
the allegedly ‘‘imperfect’’ contract functioned well for more than 5 years.
The loss that can be imposed on a nonperforming transactor by termina-
tion of the relationship is called the transactor’s reputational capital. When
sufficient reputational capital exists, self-enforcement is superior to court
enforcement. With self-enforcement, transactors know (with a lag) if their
transacting partner has or has not performed and, therefore, whether to im-
pose the termination sanction or not. Court enforcement, on the other hand,
involves interpretation of the contract terms by a third party before a non-
performance sanction is imposed. This entails both an increased time lag
and, because the contract terms used to communicate the elements of the
agreed upon performance to the third-party enforcer are necessarily imper-
fect, increased noise in determining whether the contractual understanding
has been violated. As the Fisher-GM case illustrates, the court can be used
to enforce imperfect contract terms in a way that may be contrary to the
contractual understanding of the parties and may result in a holdup.
To avoid these contract interpretation problems, when reputational capi-
tal is sufficiently large, transactors handle specific investments and potential
hold-up problems without specifying very much in their contracts and, in-
stead, rely primarily on self-enforcement mechanisms to assure perfor-
mance. For example, Japanese automobile manufacturers use largely un-
specified contracts in dealings with their parts suppliers.77 Similarly, if GM
76
Analysis of the self-enforcement mechanism is presented in Benjamin Klein & Keith
B. Leffler, The Role of Market Forces in Assuring Contractual Performance, 89 J. Pol. Econ.
615 (1981). Stewart Macaulay, Non-contractual Relations in Business: A Preliminary Study,
28 Am. Soc. Rev. 55 (1963), documents the importance of this mechanism in most business
relationships.
77
The explicit contract terms between Japanese automakers and their suppliers are short-
term and relatively unspecified, with prices adjusted downward at regular intervals as sales
increase and supplier costs fall based on an implicit understanding. See Banri Asanuma,
Manufacturer-Supplier Relationships in Japan and the Concept of Relation-Specific Skill, 3
J. Japanese & Int’l Econ. 1 (1989). The expectations of the parties are effectively self-

had possessed sufficient reputational capital or a sufficiently high cost from

not being able to use Fisher Body in the future, an imperfect long-term con-
tract would not have been necessary to assure Fisher Body that it would
not be held up by GM for its specific investments. However, because GM’s
reputational capital in this sense was limited relative to its potential to hold
up Fisher, court-enforced imperfect contract terms had to be used as a sup-
plement to self-enforcement. But as long as Fisher Body’s reputational cap-
ital or the cost to Fisher Body of not supplying bodies to GM in the future
after expiration of the current contract was sufficiently large, Fisher Body
would not have taken advantage of the imperfect contract to hold up GM.
Rather than think of court enforcement and self-enforcement as alterna-
tive enforcement mechanisms that may be chosen by transactors to assure
performance, we may think of them as complementary mechanisms used in
conjunction with one another.78 In general, the goal of contractual specifi-
cation within this framework is not to create optimal incentives on some
imperfect court-enforceable proxy for performance but to economize on the
reputational capital necessary to make a contractual relationship self-enforc-
ing in the widest range of postcontract circumstances.79 The long-term and
exclusive dealing cost-plus contract terms chosen by Fisher and GM, while
imperfect, supplemented the parties’ limited reputational capital in this
sense of facilitating performance in likely future states of the world. How-
ever, as illustrated by what occurred, the contract terms also created perfor-
mance problems in some other states of the world. When Fisher and GM
entered into their contract in 1919, they presumably believed the states of
enforced in these arrangements by the threat of nonrenewal of the supply relationship. Such
self-enforcing contractual arrangements may work especially well in Japan because of the
high levels of Japanese auto producers’ reputational capital due to (until recently) the high
level of expected future demand growth and possibly because of the increased communica-
tion and social cohesiveness often claimed to exist among participants in the Japanese econ-
omy. Similar descriptions of Japanese auto supply contracts are provided in Maschiko Aoki,
Toward an Economic Model of the Japanese Firm, 28 J. Econ. Literature 1 (1990); Michael
A. Cusumano & Akira Takeishi, Supplier Relations and Management: A Survey of Japanese,
Japanese-Transplant, and U.S. Auto Plants, 12 Strategic Mgmt. 563 (1991); Bengt Holm-
ström & John Roberts, The Boundaries of the Firm Revisited, 12 J. Econ. Persp. 73, 80–83
(Fall 1998); and Mari Sako & Susan Helper, Determinants of Trust in Supplier Relations:
Evidence from the Automotive Industry in Japan and the United States, 34 J. Econ. Behav. &
Org. 387 (1998).
78
Klein, supra note 75; and Benjamin Klein, The Role of Incomplete Contracts in Self-
Enforcing Relationships, Revue d’Economie Industrielle (in press, 2000).
79
Contract terms may accomplish this not only by (imperfectly) defining performance or
controlling nonperformance, but also by shifting rents among transacting parties. See Benja-
min Klein & Kevin M. Murphy, Vertical Restraints as Contract Enforcement Mechanisms,
31 J. Law & Econ. 265 (1988); Benjamin Klein, Distribution Restrictions Operate by Creat-
ing Dealer Profits: Explaining the Use of Maximum Resale Price Maintenance in State Oil
v. Khan, 7 Sup. Ct. Econ. Rev. 1 (1999).

the world where their contract would not be self-enforcing work were suf-
ficiently low-probability states. This is consistent with the evidence that the
Fisher-GM contract functioned well prior to 1925.
Fisher and GM expected their contractual relationship to remain self-
enforcing in the sense that it would remain within the self-enforcing range
defined by each transactor’s reputational capital. The self-enforcing range
of a contractual relationship measures the extent to which unanticipated
market conditions may change, thereby altering the gains to one or the
other party from nonperformance, yet performance is still assured because
each transactor’s reputational capital remains greater than its hold-up gain.
Changes in market conditions may alter the value of specific investments
and, therefore, the hold-up potential. Yet as long as the relationship remains
within the self-enforcing range where each transactor’s hold-up gain is less
than the self-enforcing sanction that can be imposed, a holdup will not take
place. If the large unanticipated increase in demand by GM for Fisher bod-
ies had not occurred in 1925–26, the Fisher-GM contract would have re-
mained self-enforcing, and the malincentives associated with the cost-plus
contract terms would not have mattered.
When they entered their contractual relationship and made their specific
investments, Fisher and GM presumably recognized that their reputational
capital was limited, that the written contract terms they had chosen were
imperfect and incomplete, and, therefore, that there was some probability
of a holdup occurring if changes in market conditions moved either of them
outside the self-enforcing range. This is exactly what occurred during 1925
when GM’s demand for closed bodies supplied by Fisher greatly increased.
Fisher’s hold-up gain became greater than the private sanction that could be
imposed by GM for nonperformance. The pressure placed on the imperfect
contractual agreement used to facilitate self-enforcement became greater
than what the contract could withstand, and the Fisher Body–GM relation-
ship moved outside the self-enforcing range, where Fisher found it profit-
able to take advantage of the imperfect terms of the contract to hold up
GM.80
An interesting economic question is: What was it about the large, unex-
pected demand increase by GM that caused Fisher to take advantage of the
imperfect body supply contract? Although the GM demand increase did it-
80
Freeland does not understand this analysis, claiming (supra note 5, at n.9) that I have
retreated from my earlier view that specific assets played a primary role in Fisher’s holdup
of GM and that I now believe the unanticipated increase in GM demand was, in itself, suffi-
cient to generate contract failure. Obviously, without Fisher having to make GM-specific in-
vestments, there would have been no need in the first place for the long-term, cost-plus exclu-
sive dealing contract that broke down because of the very large, unanticipated increase in
GM demand.

self increase Fisher’s short-run hold-up potential, it also increased the long-
run costs to Fisher of taking advantage of GM and, as a consequence, of
not having the GM contract renewed. Only if GM’s demand increase also
lowered the future rate of growth of GM demand (a not very likely event)
would the increase in Fisher’s short-run holdup potential exceed the in-
crease in its long-run costs of engaging in a holdup.
One factor that may explain Fisher’s behavior is that the growth in auto-
mobile demand and the movement to largely closed bodies greatly in-
creased Fisher’s leverage over GM. Since Fisher was now supplying an ab-
solutely critical input for the future survival and success of GM, Fisher
acquired the ability to expropriate rents earned by GM on all GM-specific
assets. The entire GM company was at stake if Fisher disrupted the supply
of bodies to GM. Moreover, the continued disruption of production at a
point in time when the market was growing rapidly and GM was attempting
to establish a dominant market position likely would have had large effects
on GM’s market share and sales into the future. But, whatever the economic
reason for Fisher’s behavior, it is clear that the very large, unexpected de-
mand shock in 1925 threw the Fisher-GM relationship outside the self-
enforcing range and led Fisher to take advantage of the fact that GM was
contractually obligated for another 4 years to purchase bodies at cost-plus
terms.
The holdup that occurred in Fisher-GM case shows that contract terms
in some circumstances can make things worse, that is, that increased con-
tractual specification has not only benefits, but also costs. In particular, the
contract terms used to facilitate self-enforcement by preventing GM from
holding up Fisher Body were used by Fisher to create a much greater
holdup of GM. Once an agreement is formalized in a written contract, rigid-
ity is created that can substantially increase the potential hold-up costs
when unanticipated changes occur in the market. The only way GM could
opt out of not performing to the literal imperfect terms of the long-term
Fisher Body contract, that is, not continuing to buy bodies at cost-plus from
improperly located plants until the contract expired in 1929, was to declare
bankruptcy. It is these ‘‘rigidity costs’’ associated with long-term explicit
contracts that are avoided with vertical integration.
IV. The Economic Advantages of General

Motors’s Integration with Fisher Body
The Fisher-GM case illustrates that transactors design their contracts by
combining court-enforced written contract terms with self-enforced unwrit-
ten terms so as to optimally define the self-enforcing range of their relation-
ship, that is, to minimize expected hold-up possibilities. Transactors wish

to reduce expected holdups because of the real costs they engender. For
example, when automobile bodies were produced and priced inefficiently
by Fisher during 1925–26, the total gains from trade were reduced. We can
expect in such cases for ex post renegotiation of the contract to occur so
that, after a lump sum is paid to the transactor engaging in the holdup, price
and cost will return to the efficient level. However, as the Fisher-GM case
demonstrates, this renegotiation will not be instantaneous and without
cost.81 Real resources are wasted during the renegotiation process, as the
transactor engaging in a holdup attempts to convince its transacting partner
of the extent and magnitude of the holdup and, therefore, of the side pay-
ment that must be made. It is these dissipative, purely redistributive transi-
tional costs associated with hold-up behavior that lead transactors to design
contractual arrangements that minimize the likelihood of a holdup oc-
curring.
A question that remains is why the renegotiation that occurred in the
Fisher-GM case in 1926 took the form of GM purchasing the remainder of
the Fisher Body Corporation. Although GM’s large unexpected increase in
demand for Fisher closed bodies led to a breakdown of the contractual ar-
rangement by shifting it outside the self-enforcing range, why could not
GM merely have made a lump sum payment to Fisher and continued the
contractual relationship by extending and readjusting the contract to take
account of the now larger level of sales? What advantages did GM obtain
from the use of vertical integration? Rather than attempt to answer this
question by first defining the essential characteristics of what is commonly
referred to as ‘‘the firm’’ (a definitional question upon which too much ef-
fort has been expended in the literature), we may find it more fruitful to
focus the analysis on determining the concrete changes vertical integration
made in the Fisher-GM relationship after GM acquired Fisher Body in 1926.
Most important, General Motors’s acquisition of Fisher Body involved a
shift in the operating control of Fisher Body from the Fisher brothers to
GM. This shift in operating control was accomplished in part by the shift
in ownership of all Fisher Body physical capital to GM. However, physical
capital ownership is unlikely to have been the key motivation for vertical
81
This is contrary to the assumption made in the incomplete contracting/property rights
literature that has developed from the pioneering work of Sanford J. Grossman & Oliver D.
Hart, The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration,
94 J. Pol. Econ. 691 (1986), where ex post renegotiation is assumed to be without cost. These
models focus on ex ante investment inefficiencies as the economic motivation for the organi-
zation of production. Although the reduced willingness to make specific investments (as well
as the wasteful expenditure of resources during the initial contracting process to protect
against a future holdup) are costs of hold-up behavior, the costless renegotiation formulation
of the problem makes it difficult to justify the postcontract flexibility advantages of vertical
integration emphasized here.

integration. All decision rights, that is, the legal power to take certain ac-
tions, do not shift with physical asset ownership.82 Even if GM owned all
the physical capital, including all the GM-specific dies and tooling, and
leased it or otherwise made it available to an independent Fisher Body
firm,83 there were major decisions over which Fisher would retain control.
The ownership of physical capital generally does not legally transfer all re-
sidual decision and control rights to the physical capital owner. For exam-
ple, the legal decision rights regarding the location of the plants may con-
tinue to reside in Fisher Body, and, therefore, hold-up problems like the
Flint plant disagreement are likely to remain. More important than owner-
ship of physical capital, vertical integration implies ownership of the key
intangible assets of the firm84 and, as we shall see, a fundamental change in
GM’s relationship with the Fisher brothers.
Freeland and Casadesus-Masanell and Spulber claim that a major motiva-
tion for GM’s vertical integration with Fisher Body in 1926 was the impor-
tance to GM of maintaining a relationship with the Fisher brothers. How-
ever, it is important to keep in mind that although GM found the Fishers’
expertise extremely valuable, this, by itself, merely implies the desirability
of a relationship. It does not imply a motivation for vertical integration, that
is, the particular form the relationship between GM and Fisher should take.
In fact, after vertical integration in 1926, the Fishers became employees
without any long-term employment contract, and, therefore, less of a com-
82
The contrary assumption is made in the basic Grossman & Hart (id.) framework and in
the property rights theory of the firm literature that has developed from the Grossman and
Hart model (see, for example, Oliver Hart & John Moore, Property Rights and the Nature of
the Firm, 98 J. Pol. Econ. 119 (1990); and Oliver D. Hart, Firms, Contracts and Financial
Structure (1995)). This literature recognizes the importance of allocating unspecified (or re-
sidual) contract rights to transactors but assumes that the resulting control derives solely from
physical asset ownership. The Grossman and Hart theory helps to answer incentive-type
questions, such as ‘‘Should an employee own his own tools or should they be owned by the
employer?’’ but it does not provide us with a useful theory of the firm.
83
Coase discusses this as a possible contractual solution to the hold-up problem both in
R. H. Coase, The Nature of the Firm: Origin, Meaning, Influence, 4 J. L. Econ. & Org. 3
(1988), and in Coase, supra note 4, at 17. Kirk Monteverde & David J. Teece, Appropriable
Rents and Quasi-Vertical Integration, 25 J. Law & Econ. 321 (1982), describes this as a com-
mon arrangement in the automobile industry. Also see Scott E. Masten, James W. Meehan,
Jr., & Edward A. Snyder, Vertical Integration in the U.S. Auto Industry, 12 J. Econ. Be-
hav. & Org. 265 (1989). This also was the solution adopted by Ford for body supply in the
1920s, although apparently not with much success. See Marx & Peterson, supra note 8.
84
Vertical integration transfers ownership of the firm’s brand name and other intellectual
property, the firm’s trade relationships and contracts, and the firm’s organizational capital,
that is, the team of employees and that team’s specific knowledge regarding how things are
done and how individuals work together. See Benjamin Klein, Vertical Integration as Organi-
zational Ownership: The Fisher Body–GM Relationship Revisited, 4 J. L. Econ. & Org. 199
(1988).

mitted relationship to GM existed than when the Fishers were independent

suppliers to GM operating under a long-term supply agreement.
However, when GM vertically integrated with Fisher Body, the Fishers
became employee-managers of a GM-controlled Fisher Body, rather than
independent contractors to GM. The Fisher brothers thereby lost their
ultimate legal operating authority over Fisher Body. General Motors ob-
tained much more control over Fisher Body decisions because employee-
managers, even with designated authority to make, for example, plant loca-
tion decisions, have much less ability to take advantage of their authority
for their own personal gain. Employees possess a legal obligation of loyalty
to their employer, which places important legal constraints on employee be-
havior,85 and any threat of nonperformance can be overridden by the em-
ployer. Therefore, after GM’s acquisition of Fisher Body, there could be no
problems like the hold-up problems encountered over the Flint plant.
Vertical integration permitted GM to control Fisher Body while avoiding
the difficulties created by the alternative mechanism of control, the imper-
fect long-term, fixed-price-formula body supply contract. In fact, vertical
integration eliminated the need for an automobile body supply contract alto-
gether. Rather than attempt to specify performance contractually, GM, as
the employer/owner of Fisher Body, could now more flexibly control its
employees, including the Fisher brothers, by merely instructing them to
‘‘come to work and then I’ll tell you what to do.’’ This decrease in contrac-
tual specification is a major advantage of vertical integration compared to
a long-term contract because it increases the ability of the firm owner to
coordinate production flexibly.86
Freeland, Casadesus-Masanell and Spulber, Coase,87 and Thomas Marx
and Laura Bennett Peterson88 all correctly emphasize the coordination ad-
85
Scott E. Masten, A Legal Basis for the Firm, 4 J. L. Econ. & Org. 181 (1988). This is
contrary to the Grossman and Hart formulation of the problem, where it is asserted that be-
cause ‘‘it is difficult to write a complete contract between a buyer and seller and this creates
room for opportunistic behavior, the transactions cost–based arguments for integration do not
explain how the scope for such behavior changes when one of the self-interested owners
becomes an equally self-interested employee of the other firm’’ (Grossman & Hart, supra
note 81, at 692). In addition to changing the legal constraints on the transaction, GM now
owns the Fisher team of employees who cannot jointly collude in holding up GM. See Klein,
supra note 84. There is absolutely no basis for Freeland’s assertion that vertical integration
makes specific human capital hold-up problems worse.
86
In the Grossman and Hart framework, in contrast, the contractually unspecified residual
is assumed to be unaffected by the organizational form. In particular, the framework ignores
the fact that the use of a firm-type organization (including an employment relationship) gen-
erally implies a greater unspecified contractual residual.
87
See Coase, Nature of the Firm, supra note 83; Coase, supra note 4.
88
Marx & Peterson, supra note 8.

vantages of vertical integration.89 But they do not explain how vertical inte-
gration facilitates coordination. In particular, they do not recognize the ad-
vantages of vertical integration in reducing contractual specification and,
therefore, reducing reliance on the courts to enforce necessarily imperfect
and rigid long-term contracts.90
Because the coordination advantages of vertical integration involve
avoiding the rigidity costs of long-term contracts, the advantages of vertical
integration depend upon the presence of specific investments and insuffi-
cient reputational capital, the conditions that lead to the use of long-term
contracts. When transactors do not make specific investments, they can co-
ordinate their activities in a spot market without using long-term contracts.
For example, GM could have contracted for bodies and purchased bodies
on such a basis from Fisher Body. This would have avoided the potential
hold-up problems associated with a rigid and imperfect long-term contract
and preserved GM’s ability to coordinate body supply flexibly.
89
Freeland also claims that GM was motivated to vertically integrate with Fisher by the
anticompetitive desire to deprive competitors of access to Fisher’s bodies. However, while
Fisher Body had a large share of U.S. closed body production (50 percent in 1919 and 60
percent by 1926 (see E. D. Kennedy, The Automobile Industry: The Coming of Age of Capi-
talism’s Favorite Child (1972)), there were other independent body suppliers, the most im-
portant of which were Briggs Manufacturing Company (which became Chrysler’s main sup-
plier in 1927 and supplied bodies to Ford) and Murray Corporation of America (which also
supplied bodies to Ford). See Body by Briggs, supra note 8, at 25. Freeland’s claim that
Ford’s very significant problems in the mid-1920s in switching its production from the stan-
dardized, primarily open-car design Model T to the closed-body Model A were largely due
to GM’s acquisition of Fisher Body has no basis in fact. Although some other automobile
manufacturers initially did poorly in the switch over to the new closed-body, style-conscious
environment, most companies other than Ford had no trouble quickly recovering in spite of
the fact that they could not purchase bodies from Fisher. Chrysler’s market share, which was
3.1 percent in 1925, was 5.4 percent in 1927, Hudson’s share was 6.3 percent in 1925 and
8.1 percent in 1927, and Studebaker’s share was 3.1 percent in 1925 and 3.5 percent in 1927.
General Motors’s market share increase from 18.5 percent in 1925 to 43.3 percent in 1927,
a level at which it remained for nearly 50 years, came entirely at the expense of Ford, with
Ford’s share dropping from 38.5 percent in 1925 to 10.5 percent in 1927. All the evidence
indicates that Ford’s problems were due to its failure to adapt to the annual model change
environment. See Sloan, supra note 23; James J. Bradley & Richard M. Langworth, Calendar
Year Production: 1896 to Date, in The American Car since 1775 (Automobile Quarterly ed.,
2d ed. 1971).
90
In contrast, Casadesus-Masanell and Spulber claim that vertical integration facilitated
coordination by ameliorating the high transportation and communication costs present in the
economy at the time. But the change in organizational structure produced by vertical integra-
tion does not reduce transportation costs by physically moving the body operation into the
automobile plant. And, although a number of authors have emphasized the benefit to verti-
cally integrated firms of obtaining information about supply conditions earlier than noninte-
grated firms (for example, Kenneth J. Arrow, Vertical Integration and Communication, 6 Bell
J. Econ. 173 (1975)), the Flint Buick plant location problem that arose in the Fisher-GM case
was not a question of insufficient information. General Motors knew where it wanted to put
its plant; it did not require market information from Fisher to determine the efficient location.

Even when specific investments are involved, flexible coordination may

occur without the need for vertical integration if sufficient reputational capi-
tal exists. The Japanese auto supply contracts are an obvious example of
this. In general, as long as contracts can define performance precisely
enough that the residual, unspecified elements of performance are more
than sufficiently covered by the parties’ reputational capital, transactors will
have the ability to make required flexible adjustments over time. It is only
when the necessary contractual specification becomes too rigid because ex-
pected changes are too large relative to the parties’ reputation capital that
vertical integration is the preferred way to facilitate self-enforcement and
thereby achieve flexible coordination.91
These coordination advantages of vertical integration became especially
important in the automobile industry after annual model change programs
were instituted by the automobile manufacturers in 1925.92 As body design
became more important and more interrelated with chassis design and pro-
duction, the amount of coordination required between a body supplier and
its automobile manufacturer customer increased substantially. This made it
more difficult to specify performance contractually in a way precise enough
that a long-term contract would almost always remain within the self-
enforcing range.
The growth in demand for annually changing closed bodies can be
thought of as an increase in contractual uncertainty, and the movement to
vertical integration as consistent with the frequently noted but unexplained
relationship between increased uncertainty and vertical integration.93 In-
91
In contrast to the flexible Japanese auto parts supply contracts, the recent contract be-
tween the Lear Seating Company and Ford is a prime example of a failed rigid contract be-
tween an auto part supplier and an automobile company. Lear was contractually designated
the sole supplier of seats for the new 1996 model Ford Taurus, with the contract providing
that Lear would be compensated for investments associated with design changes. Although
Lear apparently met the original contract terms, inferior seats would have been supplied if
significant changes had not been made. Consequently, Ford had no choice but to pay large
sums in order to receive acceptable seats. At one point, for example, Lear requested an addi-
tional $4 million to cover unexpected engineering costs, plus an additional $70 per seat for
content and labor. ‘‘There were people at Lear who couldn’t believe Ford had gotten itself
in this position. . . . Ford was crazy—Lear had them by the short hairs. ‘They can keep
saying they need more money and more money, and Ford has nowhere to go.’ ’’ See Mary
Walton, Car: A Drama of the American Workplace 196 (1997). This case provides a very
interesting contrast to the flexible Japanese auto parts supply contracts.
92
Annual model changes were adopted by most automobile manufacturers other than Ford
and necessitated large increases in annual industry investments for new dies and tooling. See
Thomas, supra note 8.
93
The empirical relationship between vertical integration and uncertainty is documented
by George John & Barton A. Weitz, Forward Integration into Distribution: An Empirical Test
of Transaction Cost Analysis, 4 J. L. Econ. & Org. 337 (1988), which find uncertainty posi-
tively affects the decision to use an in-house sales force for a sample of industrial manufac-
turing companies; Erin Anderson, The Salesperson as Outside Agent or Employee: A Trans-

creased uncertainty leads to vertical integration because it makes it more

likely that the alternative of an explicitly specified long-term contract, such
as the Fisher-GM contract, will move outside the self-enforcing range.
Therefore, increased uncertainty induces vertical integration (even if trans-
actors are risk neutral) because it increases the likelihood of contractual
failure, with its associated hold-up costs.94 When the variance of market
conditions increases, the value of the hold-up option present in every imper-
fect contract also increases, making vertical integration, with its increased
ability to make flexible postcontract adjustments, more likely.95
These economic forces connected with annual model changes ultimately
led all automobile manufacturers to adopt vertical integration. Ford, the
action Cost Analysis, 4 Marketing Sci. 234 (1985), which finds a similar positive relationship
on the use of an in-house sales force only when uncertainty is interacted with asset specific-
ity; and Joseph P. H. Fan, Price Uncertainty and Vertical Integration: An Empirical Examina-
tion of Petrochemical Firms (unpublished manuscript, Hong Kong Univ. Sci. & Tech. 1999),
for petrochemical firms. Dennis Carlton, Vertical Integration in Competitive Markets under
Uncertainty, 27 J. Indus. Econ. 189 (1979), explained this relationship in the context of a
model where uncertain price changes lead to rationing, although it is unclear why this would
not merely lead to long-term contracts. In contrast to my analysis, in Carlton’s model price
uncertainty creates no incentive for vertical integration if markets clear.
94
This effect is distinct from the effect of increased uncertainty on the increased incom-
pleteness of contracts because of an increase in the number of contractual contingencies. If
the parties are risk neutral, increased incompleteness, in itself, has no effect on vertical inte-
gration. That is why uncertainty has no role in the property rights (Grossman and Hart–type)
approach to the theory of the firm. If the parties are risk neutral, then increased uncertainty
and increased contractual incompleteness do not affect organizational form or, in particular,
which party owns which assets because these models ignore self-enforcement. An important
recent paper by George Baker, Robert Gibbons, and Kevin Murphy that extends the Gross-
man and Hart model with self-enforcement claims a positive effect of ex ante uncertainty on
vertical integration. However, although the authors provide a number of valuable insights
regarding the operation of the self-enforcement mechanism, the ‘‘price uncertainty’’ effect
in this model is not what empirical researchers are referring to as market uncertainty. Baker,
Gibbons, and Murphy do not identify what I consider to be the key advantage of vertical
integration that facilitates self-enforcement in an uncertain environment, namely, postcontract
flexibility. George Baker, Robert Gibbons, & Kevin Murphy, Relational Contracts and the
Theory of the Firm (Working paper, Harvard Univ. 1999).
95
In Klein, supra note 75, I show that when parties enter a contractual relationship they
can be thought of as buying and selling what amount to options related to the probability of
a holdup occurring. As in standard options-pricing theory, the values of these options in-
crease as the value of the ratio of the underlying asset price increases relative to the exercise
price (in our case, as the value of the hold-up potential increases relative to the transactor’s
reputational capital) and as the variance per period of the asset price multiplied by the num-
ber of periods increases (in our case, as the variance of underlying market conditions multi-
plied by the length of the contract increases). This analysis is similar, in effect, to Oliver
Williamson, The Economic Institutions of Capitalism 5659 (1985), where the combination
of asset specificity and uncertainty leads to a greater need for ex post adjustments in the
relationship and, hence, the efficiency of what he refers to as a hierarchical relationship,
where one party has control over the transaction. However, Williamson does not place his
analysis within a self-enforcing framework.

company that resisted the movement to annual model changes to the great-
est extent, continued to rely largely on outside suppliers for its bodies until
1939. Ford used a cost-plus ‘‘open book’’ contract with its body suppliers,
where suppliers had to provide Ford with detailed breakdowns of costs and
complete access to their accounting records, while Ford itself made the nec-
essary investments in Ford-specific tooling.96 General Motors’s full integra-
tion with Fisher Body, by contrast, occurred before any other company de-
cided to vertically integrate fully, possibly because of the importance of
annual model changes to the primary GM marketing thrust in the 1920s and
possibly because Fisher’s holdup and GM’s associated production problems
in 1925–26 made GM more sensitive to the necessity of controlling Fisher
Body.
V. Conclusion
In order to advance our economic understanding, it is necessary to get
our hands dirty and learn how particular contracts actually work in practice.
I agree completely with Coase’s warning that ‘‘theory is outrunning our
knowledge of the facts in the study of industrial organization and that more
empirical work is required if we are to make progress.’’ 97 Learning how a
particular contractual arrangement operated is exactly what I have at-
tempted to accomplish with my examination of the Fisher-GM case. When
one studies the details of this case, the evidence is unambiguous that the
long-term contract governing the relationship between GM and Fisher
broke down during 1925 and led to vertical integration in 1926. During
1925–26 Fisher used the fact that GM was locked in to an imperfect supply
contract to increase its short-term profit by inefficiently building bodies in
Detroit and shipping them to Flint, rather than constructing a body plant
adjacent to the GM facilities in Flint.
Coase and Freeland agree on these fundamental facts surrounding the
Flint plant disagreement that immediately preceded GM’s vertical inte-
gration with Fisher Body. (Casadesus-Masanell and Spulber inexplicably
fail to discuss this episode at all.) What Coase and Freeland lack is a use-
ful organizing framework in which to interpret these facts. In particular,
Coase’s insistence that the Flint plant experience was an outlier and that
Fisher previously constructed a number of other plants adjacent to GM pro-
duction facilities fails to recognize that contractual arrangements may oper-
ate perfectly well for a period of time before breaking down and leading to
a new organizational form. And Freeland’s view that Fisher’s reluctance to
96
Body by Briggs, supra note 8.
97
R. H. Coase, Contracts and the Activities of Firms, 34 J. Law & Econ. 451 (1991).

make new, large investments in Flint was understandable does not mean
that Fisher’s behavior in taking advantage of the fact that GM was locked
in to an exclusive dealing contract did not constitute a holdup.
Contrary to Coase’s original formulation of the problem that simply con-
trasts ‘‘the firm’’ with ‘‘the market,’’ the above analysis shows that it is
useful to think of all arrangements, including vertical integration, as forms
of market contracts chosen by transactors to supplement self-enforcement
when transactors have limited reputational capital. To determine the condi-
tions under which vertical integration is the particular self-enforcing con-
tractual arrangement that is likely to be used, it is important to consider
more than the narrow transaction costs of spot contracting (discovering
prices and executing contracts) upon which Coase focuses. The much more
important economic determinants of vertical integration are the contracting
costs illustrated so vividly in the Fisher-GM case, namely, the rigidity costs
associated with court enforcement of imperfect long-term contract terms.
The importance of these rigidity costs and the ability of transactors to avoid
such costs with a more flexible vertical integration arrangement (at the cost
of weakening individual incentives) are the main economic lessons of the
Fisher-GM case.
Although Coase is correct that transactor-specific investments and hold-
up problems can normally be handled with long-term contracts (and some-
times are even handled well with short-term contracts when sufficient repu-
tational capital exists), the rigidity costs associated with long-term contracts
increase as relationship-specific investments increase. Holding constant both
the difficulties of specifying contractual performance (which may, in fact,
have increased after GM moved to an annual model change program) and
the level of the transactors’ reputational capital, the greater the relationship-
specific investments, the more likely it is that transactors will have to use
explicit long-term contract terms in their arrangement to assure perfor-
mance. Therefore, the greater the relationship-specific investments present
in an exchange, the more likely vertical integration (that avoids the rigid-
ity costs associated with long-term contracts) will be chosen as the self-
enforcing contractual arrangement. All that is required for this positive
relationship between specific investments and the likelihood of vertical inte-
gration is that the relative inefficiency costs of vertical integration from the
weakening of incentives not be systematically positively related to the level
of specific investments, and there is no reason to believe they are.
This analysis does not imply that vertical integration will always be used
when large specific investments are present. As Bengt Holmström and John
Roberts discuss in detail,98 there are many examples of large specific invest-
98
Holmström & Roberts, supra note 77.

ments and incomplete contracts where we do not observe vertical integra-

tion. However, contrary to Holmström and Roberts’s conclusion, this evi-
dence is not inconsistent with what they call the transaction cost theory (or
what, more generally, should be called the contracting cost theory) of ver-
tical integration. Because of the incentive costs associated with vertical
integration, transactors always prefer a contractual arrangement that keeps
transactors independent if performance can be assured without too much
rigidity. Therefore, if sufficient reputational capital exists or if performance
can be measured ex ante reasonably accurately, transactors will be able to
solve the hold-up problem with a flexible contractual arrangement (or
sometimes with essentially no contract at all, as in the case of Japanese auto
suppliers).
Although there is substantial variability in the contractual arrangements
and organizational forms used by transactors in the presence of relationship-
specific investments, the theory illustrated by the Fisher-GM case merely
implies that the greater these relationship-specific investments, ceteris pari-
bus, the greater the likelihood vertical integration will be used to minimize
the expected hold-up costs. Without specific investments and the associ-
ated hold-up problem, there is no reason for a long-term contract and, there-
fore, no reason to use vertical integration as a substitute for a rigid
long-term contract. More generally, the key to understanding variations in
contractual arrangements, including the incidence of vertical integration,
lies in analyzing how particular arrangements may efficiently facilitate self-
enforcement.
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The University of Chicago

The Booth School of Business of the University of Chicago

Fisher—General Motors and the Nature of the Firm

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Ronald Coase’s landmark contribution in The Nature of the Firm fun- 1

damentally changed the way we look at economic institutions. Coase recog-

* Professor of Economics, University of California, Los Angeles. I am indebted to Ryan

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problems that arise when transactors use imperfect long-term contracts to

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II. The Holdup of General Motors by Fisher Body

A. The Fisher Body–General Motors 1919 Supply Agreement

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Fisher’s investments were not GM-specific. However, although composite

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B. General Motors Did Not Obtain Control of Fisher Body in 1919

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C. 1919–24: The Fisher–General Motors Contract Works Well

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to GM to build or purchase a number of assembly plants.19 These plants

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Year Location Terms of Acquisition Plant Size Near GM Division

All use subject to JSTOR Terms and Conditions

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E. Fisher’s Flint Plant Holdup of General Motors

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Coase also dismisses the Flint plant episode as merely a disagreement

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F. Freeland’s Claim That the Flint Plant Disagreement

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Freeland presents three additional arguments that, he claims, convinc-

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ored, Lawrence Fisher explicitly testified that the management of Fisher

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Fisher brothers’ ownership interest in Fisher Body Corporation was about

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G. Defining Hold-Up Behavior: 1925–26 versus 1933–34

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substantial premium in 1926, to ‘‘pay yet again’’ in 1934.68 This is a gross

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GM outside of their participation in the stock incentive plan. Since the

III. Why the Fisher Body Holdup of General Motors Occurred

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had possessed sufficient reputational capital or a sufficiently high cost from

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IV. The Economic Advantages of General

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mitted relationship to GM existed than when the Fishers were independent

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