Optimal Contracting in Networks
89 Pages Posted: 5 May 2016 Last revised: 17 Aug 2018
Date Written: April 1, 2016
We study optimal contracting between a firm selling a divisible good that exhibits positive externality and a group of agents in a social network. The extent of externality that each agent receives from the consumption of neighboring agents is privately held and is unknown to the firm. By explicitly characterizing the optimal multilateral contract, we demonstrate how inefficiency in one agent’s trade propagates through the network and creates unequal and network-dependent downward distortion in other agents’ trades. We also explicitly describe bilateral contracts (i.e., the non-linear pricing) and characterize their explicit dependence on the network structure. We show that firm will benefit from uncertainty in agents’ valuation of other agent’s externality. We further elucidate the profit gap between multilateral and bilateral contracts and analyze the consequences of the explicit dependence of the contracts on network structure. When the network is balanced in terms of homogeneity of agents’ influence, network structure has no impact on the firm’s profit when contracts are bilateral. On the other hand, when the influences are heterogeneous with high dispersion (as in core-periphery networks) the restriction to bilateral contracts can result in profit losses that grow unboundedly with the size of networks.
Keywords: Network Economics. Information rent. Asymmetric information. Multilateral contracts. Bilateral contracts
JEL Classification: D82. D86. D42
Suggested Citation: Suggested Citation