Stable Partnerships and Monitoring Design

Abstract

We study dynamic partnerships where players can choose to exit, and those who have exited continue to accrue benefits as long as some remaining players keep contributing to the partnership. We characterize the conditions for a partnership to be stable in the sense that no player exits on the equilibrium path. We show that a partnership switches between being stable and unstable as the number of players grows, and increasing players' abilities may harm a partnership. Moreover, when players can choose efforts over time in addition to their exit decisions, noisy monitoring of other players' efforts can facilitate cooperation. We design a simple monitoring structure called noisy pass-or-fail that achieves the first-best outcome.

Keywords: partnerships, free-riding, monitoring, ripple effect, contractual equilibrium

JEL Classification: C73, D62, L20