In our new paper, we offer a resolution to a longstanding puzzle in contract theory: Why do practitioners in several categories of high-stakes corporate transactions (such as M&A and financings) routinely fix price terms early, while leaving non-price terms to be negotiated later – precisely the opposite of what conventional theory prescribes? Contract theory teaches that non-price terms, which directly influence joint welfare, should be set relatively early, reserving price as a final adjustment mechanism to balance any resulting disparities. In practice, however, price is often locked in at (or near) the onset of negotiations, a practice that seems to defy economic wisdom in some of the highest-stakes contracts.

Our paper presents a novel framework that helps reconcile this apparent disjunction between theory and practice. By integrating a bargaining model with a search game for discovering innovative contractual provisions, we offer a fresh perspective on why fixing the price first can, in fact, be optimal under a robust set of conditions. Our analysis not only offers a solution to this enduring puzzle but also generates empirically testable implications for when and why price-first bargaining might be preferable.

The Puzzle: Theory vs. Practice in Contract Sequencing

At the heart of our inquiry is a significant paradox. Contract theory, a pedigreed field featuring the work of multiple Nobel Prize winners, overwhelmingly posits that price should be the last term that crystalizes in negotiations. After all, the contract price is a flexible, zero-sum mechanism for adjusting payoffs after non-price terms – such as covenants, conditions, and warranties – have been optimized to maximize joint surplus. Fixing price last, according to theory, allows negotiators to “grease the wheels” by fine-tuning deals to ensure maximal mutual benefit.

In practice, however, the opposite is often true. In large corporate transactions, executives typically lock in price terms early through term sheets or letters of intent, leaving non-price terms to be finalized later by legal and financial specialists. Revisiting price is rare and is generally discouraged by institutional norms and reputational considerations. This practice raises a fundamental question: Why would sophisticated negotiators of billion-dollar deals systematically disregard the theoretically optimal sequence?

An Incentive-Based Explanation: Fixing Price to Encourage Innovation

Our solution to this puzzle centers on the incentive effects of fixing the deal price early. We argue that locking in price at the outset can often improve incentives for parties to engage in the costly and uncertain search for innovative non-price terms.

The intuition is as follows: If price remains negotiable until the end, any party that invests effort in discovering valuable non-price terms risks having the benefits of those terms expropriated by a stronger counterparty during final price negotiations. This fear of expropriation can stifle incentives to invest in searching for and developing novel contractual terms. By fixing price first, negotiators effectively create a stable framework that preserves incentives for both sides to augment joint value through non-price terms without the risk of having their efforts snatched away through subsequent price concessions.

In certain ways, our argument draws a pre-contractual parallel to the well-known post-contractual holdup problem in contract theory, where parties to long-term contracts hesitate to invest in relationship-specific assets for fear of opportunistic renegotiation. Here, the “asset” is the nascent contract itself, and investments take the form of efforts to uncover innovative non-price terms in a still-executory deal. Fixing price early serves as a safeguard that preserves incentives for efficient contract design with reduced fears of subsequent rent extraction.

Empirical Implications and Testable Predictions

Our framework also leads to a series of testable implications that distinguish between price-first and price-last negotiation regimes. For example, we predict that in transactions where the expected payoffs for discovering valuable non-price terms are considerable, we should observe a greater prevalence of price-first bargaining. This is particularly true in high-stakes deals involving sophisticated parties who possess the expertise and resources to explore complex non-price provisions effectively. Conversely, in smaller transactions – such as used car sales or residential real estate deals – we expect to see the canonical price-last model more frequently. In these settings, the value added from innovative non-price terms is smaller, making the flexibility of price adjustments more valuable than the potential gains from non-price innovations. This bifurcation in sequencing practices aligns well with observed patterns in various markets and provides a plausible explanation for why contract theory appears to apply more cleanly in smaller deals than in large-scale corporate transactions.

Our analysis also provides insights about deal failure as an equilibrium phenomenon. In our model, it can be perfectly rational for parties to sign up a boilerplate preliminary deal that decreases their expected joint payoffs, with the expectation that the ensuing search efforts (in the shadow of a locked-in price) will bridge the valuation gap through efficient deviations from the boilerplate. Such expectations – while rational – are still risky, thereby giving rise to frequent failures after the preliminary deal is struck, where the parties fail at term innovation in equilibrium notwithstanding their efforts.

Legal Doctrines and Preliminary Agreements: A Fresh Lens

Our analysis also offers new insights into several legal doctrines and contracting norms. For instance, U.S. courts have increasingly enforced preliminary agreements that leave some terms open, provided the parties demonstrate good-faith efforts to finalize the contract. Our framework suggests that such enforcement is consistent with encouraging efficient search for non-price terms, particularly when price is fixed early.

Additionally, our framework provides a rationale for the widespread use of boilerplate terms (at least at the start) in high-stakes transactions. By fixing price first, negotiators can use standard-form terms as a baseline while focusing their search efforts on a smaller set of bespoke, value-enhancing provisions. This approach balances efficiency with flexibility, allowing negotiators to concentrate on areas of the contract where innovative terms are most likely to yield substantial welfare gains.

Implications for Deal-Making and Contract Design

Our findings have significant implications for both practitioners and scholars. For practitioners, the insights suggest that fixing price early might be a strategically sound approach in transactions with significant scope for innovation in non-price terms. Furthermore, our analysis underscores the importance of having skilled legal counsel capable of navigating the complexities of non-price terms – a factor that can dramatically influence the overall value of the deal.

For scholars, our framework opens new avenues for research. By integrating a search model with a bargaining framework, we introduce a new way of thinking about contract design that emphasizes the endogenous discovery of contract terms, as opposed to treating them as exogenously given. This perspective not only helps reconcile theory and practice but also suggests new empirical approaches for studying contract negotiations in high-stakes environments.

Conclusion: A New Perspective on Contract Sequencing

In our article, we offer a new perspective on contract sequencing that helps resolve a longstanding puzzle in contract design. By highlighting the incentive effects of fixing price first, our analysis provides a plausible explanation for why sophisticated negotiators often do just that in high-stakes transactions. Our framework also has broader implications for legal doctrines, economic theory, and practical deal-making strategies.

We hope that our efforts will – much like a fixed-price term sheet – catalyze subsequent search by scholars and practitioners alike into the drivers and dynamics of contract design, especially in our understanding of the complex and frequently puzzling interplay between price and non-price terms in high-stakes transactions.

This post comes to us from Joshua Higbee at University of Chicago, Matthew Jennejohn at BYU Law School, Cree Jones at BYU Law School, and Eric Talley at Columbia Law School. It is based on their new working paper, “Fix the Price or Price the Fix? Resolving the Sequencing Puzzle in Corporate Contracting,”  available here.