If you are offered the Right of First Refusal, should you accept? An investigation of contract design

Rights of first refusal are contract clauses that, recognizing the incompleteness of contracts, are intended to provide the holder of a license or lease with some protection when the contract comes to an end. The simplest right of first refusal gives the right holder the ability to act after potential competitors. However, another common implementation of a right of first refusal requires the right holder to accept or reject some offers before potential competitors are given the same offer, and, if the right holder rejects the initial offer, allows the right to be exercised affirmatively only if competitors are subsequently offered a better deal (e.g. a lower price). We explore, theoretically and experimentally, the impact this latter form of right of first refusal can have on the outcome of a negotiation. We show that, counterintuitively, the “right” embodied in this form of right of first refusal can work to the disadvantage of its holder. This suggests that applied contract design may benefit from the same kind of attention to detail that has begun to be given to practical market design. JEL classification: C78, C91, K12