The Option Value of Contract Duration: Evidence from the U.S. Timber Market

TL;DR

This paper investigates how extending contract durations in the US timber market affects buyers' willingness-to-pay and seller revenue, highlighting the strategic delay of consumption and its impact on market outcomes.

Contribution

It provides the first empirical analysis of how contract duration influences buyer behavior and seller revenue using structural estimation and counterfactual simulations in the timber industry.

Findings

Longer contracts increase seller revenue by 9-13%.

Buyers delay consumption to manage risk, creating heterogeneous WTP.

Effects are stronger for larger projects and during upward market trends.

Abstract

This study quantifies how contract duration influences buyers' willingness-to-pay (WTP) when they hold real options that allow them to flexibly time consumption in response to changing market conditions. Using contract data from the US timber industry, we show that buyers delay consumption to manage payoff risk. This behavior generates heterogeneous WTP across buyers. We use structural estimation to uncover the key parameters underlying the incentive to delay consumption. Using these estimates, we conduct counterfactual simulations to measure how longer contract durations shift WTP and to clarify the boundary conditions linked to project size, buyer composition, and market trends. The counterfactual simulations reveal that extending contract duration from 3 to 4 years raises seller revenue by 9-13%, with effects amplified for larger projects and high-type buyers during the upward market trend.