Right of First RefusalDebrief Questions and answers1. What is a right of first refusal clause worth? How do you value it?In our experiment, valuing the clause is straightforward---simply project the salary under the scenario without the clause and compare it to the scenario with the clause in place. That is, we can use game theory to determine the outcomes under each of the scenarios (using Look Forward, Reason Back as in problem set 1) to get a handle on the value of the clause. Alternatives: One might have thought of the clause as being an option (which it is) and used the Black-Scholes option pricing formula from finance. Notice, however, that this is not a viable option for one compelling reason: The clause is only valuable when it is not exercised. When the clause isn’t exercise, competition has been effectively blocked by the presence of the clause. This is a fundamental difference between a conventional option, which provides value in the face of uncertainty, and a game-theoretic option, which is designed to alter the strategic behavior of rivals and thereby confer a competitive advantage. 2. The restrictive free agency clause was put into the CBA “for the good of the game”---to keep teams from losing their star players and thereby create fan interest with team stability. Is that really right?It’s not correct. In all cases, the player remained with the incumbent team for the simple reason that the value proposition was higher for the match between player and incumbent versus rival and incumbent. Indeed, if the rival team had valued the player more highly, the ROFR clause wouldn’t have protected the incumbent team at all. To see this, suppose the ROFR clause is in place and the rival values the player at $12 million (less a $500k transaction cost). Then regardless of the ROFR clause or the incumbent’s initial offer, the rival can bid away the player at a salary of $10 million. 3. Are there other business examples of the use of this clause?We came up with several examples:1. VC’s often put ROFR clauses into contracts with entrepreneurs to protect themselves from competition for future financing in the event the entrepreneur’s project is a success.2. Commodities suppliers can use ROFR clauses in a position of temporary advantage to preserve their leverage with a downstream firm.3. The Meet or Release clauses in NutraSweet’s contracts with Coke and Pepsi at thetime it was facing imminent competition from the Holland Sweetener Company illustrate how these clauses can be used by a patent protected business to effectively “extend” the life of its patent by forestalling
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