Strategic Delegation by Unobservable Incentive Contracts

Abstract

Many strategic interactions in the real world take place among delegates empowered to act on behalf of others. Although there may be a multitude of reasons why delegation arises in reality, one intriguing possibility is that it yields a strategic advantage to the delegating party. In the case where only one party has the option to delegate, we analyze the possibility that strategic delegation arises as an equilibrium outcome under completely unobservable incentive contracts within the class of two-person extensive form games. We show that delegation may arise solely due to strategic reasons in quite general economic environments even under unobservable contracts. Furthermore, under some reasonable restrictions on out-of-equilibrium beliefs and actions of the outside party, strategic delegation is shown to be the only equilibrium outcome.

Commitment without reputation: renegotiation-proof contracts under asymmetric information

“…In this case, condition (2) would have the individually rational payoff defined as b 2 ). In that case, the result would be the exact analog of those in models without asymmetric information, i.e., Koçkesen and Ok (2004) and Koçkesen (2007).…”

“…The effects of unobservable and non-renegotiable third-party contracts are also well-understood: Nash equilibrium outcomes of a game with and without third-party contracts are identical (Katz (1991)). In fact, all (and only) Nash equilibrium outcomes of the original game can be supported as a sequential equilibrium outcome of the game with unobservable and non-renegotiable contracts (Koçkesen and Ok (2004) and Koçkesen (2007)). 3 The strategic role of renegotiable contracts is less understood and the pioneering contribution is provided by Dewatripont (1988 Dewatripont (1988), is that by allowing secret renegotiation, Caillaud et al (1995) enhanced the realism of the model and clarified the role of strategic contracting.…”

Optimal collusion with internal contracting

“…The continuation value v i LL is lower than other values and is chosen to satisfy the binding On-IC i H in (22). In SPPE, continuation-value transfers across firms are wasteful; any variation of continuation values entails some inefficiency and is suffered by all firms together.…”

“…Lee (2003) argues that the scope of intertemporal price discrimination may diminish if a monopolist has more information as to consumers' past purchasing history. 10 Vickers (1985), Fershtman and Judd (1987), Katz (1991), Reitman (1993), Sklivas (1987), Spagnolo (2000), and Kockesen and Ok (2004) show that incentive contracts with delegated agents can serve as a strategic commitment device.…”

Games played in a contracting environment

“…[6]), which emphasizes that delegation with public contracts allowed a principal to secure favorable outcomes. Katz [11], Fershtman and Kalai [7] and Kockesen and Ok [12] examine the implications of private contracting in this context, while Caillaud et. al.…”