CONTRACTING WITH SPATIAL EXTERNALITIES AND AGENCY PROBLEMS - THE CASEOF RETAIL LEASES

This paper examines leasing arrangements between a shopping center lan dlord/developer and individual stores in the presence of inter-store s hopping externalities. The problem is to design individual leases so t hat (i) stores internalize inter-store externalities, and () the landl ord does not underprovide marketing effort that is beneficial to all s tores. We show that the key element for achieving these goals is the a bility of the landlord to cancel the leases of stores whose sales fail to achieve a target level. Such cancellation, or 'recapture', clauses are common in commercial leases. We also show that in the absence of such a clause, familiar types of commercial leases fail to achieve the above objectives.