I'll Pay You Later: Relational Contracts in the Oil Industry
Abstract: International contracts are difficult to enforce, in particular in the presence of weak institutions. Resource rich economies can hold-up multinational oil companies by renegotiating tax payments after investments occurred. Anticipating such events, firms can avoid such hold-ups by devising self-enforcing agreements and relying on future gains from trade. Theoretically, this can be achieved by back-loading investments, production and tax flows. Using the universe of contracts between resource rich economies and the seven largest multinationals (Big Oil) since 1950, we show that contracts between the multinationals and resource rich economies with weak institutions are back-loaded relative to countries with strong institutions. This pattern is robust to a variety of definitions, choices of sub-samples and a large number of controls. By exploiting the timing of the first oil price shock, we show that the back-loading in countries with weak institutions only emerges in the data in early 1970s, while we do not find any evidence for back-loading between 1950 and 1970. We attribute this to binding political constraints which would not allow the US to use its military power to enforce contracts since the early 1970s and which became public knowledge during the events surrounding the Yom Kippur War in 1973.
