Strategic Exits in Stochastic Partnerships

Abstract

We study dynamic partnerships where the output evolves stochastically, each player can exit at any time, and players who have exited continue to accrue some benefits if the remaining players keep contributing to the partnership. Players can strategically exit to free-ride on their partners' contributions, knowing that it may trigger subsequent exits of their partners. The unique Pareto optimal Markov perfect equilibrium may feature a \textit{curse of profitability}: An increase in the partnership's output may strictly harm all the players by exacerbating free-riding. Another main finding is that a partnership's ability to sustain cooperation is non-monotonic in its group size.

Keywords: partnerships, strategic exits, ripple effect, group size, stochastic stopping games.

JEL Classification: C73, D62, L22