A Theory of Endogenous Commitment
CEMFI Working Paper No. 0206
40 Pages Posted: 13 Oct 2002
Date Written: February 28, 2003
Commitment is typically modeled by giving one of the players the opportunity to take an initial binding action. The drawback to this approach is that the fundamental question of who has the opportunity to commit is driven by a modeling decision. This paper presents a framework in which commitment power arises naturally from the fundamentals of the model. We construct a finite dynamic game in which players are given the option to change their minds as often as they want, but pay a switching cost if they do so. We show that for two-player games there is a unique subgame perfect equilibrium with a simple structure. This equilibrium is independent of the order of moves and robust to other protocol specifications. Moreover, despite the perfect information nature of the model and the costly switches, strategic delays may arise in equilibrium. The flexibility of the model allows us to apply it to many different environments. In particular, we study an entrydeterrence situation and a bargaining setting. The predictions for these are intuitive and illustrate how commitment power is endogenously determined.
Keywords: Commitment, entry, switching costs
JEL Classification: C7, C73
Suggested Citation: Suggested Citation