Contracts and Externalities: How Things Fall Apart

30 Pages Posted: 26 Nov 2003

See all articles by Garance Genicot

Garance Genicot

Georgetown University - Department of Economics

Debraj Ray

New York University (NYU) - Department of Economics; Autonomous University of Barcelona - Instituto de Analisis Economico (CSIC)

Date Written: June 2003

Abstract

A single principal interacts with several agents, offering them contracts. The crucial assumption of this paper is that the outside-option payoffs of the agents depend positively on how many "free agents" there are (these are agents who are not under contract). We study how such a principal, unwelcome though he may be, approaches the problem of contract provision to agents when coordination failure among the latter group is explicitly ruled out. Two variants are studied. When the principal cannot re-approach agents, there is a unique equilibrium, in which contract provision is split up into two phases. In phase 1, simultaneous offers at good (though varying) terms are made to a number of agents. In phase 2, offers must be made sequentially, and their values are "discontinuously" lower: they are close to the very lowest of all the outside options. When the principal can repeatedly approach the same agent, there is a multiplicity of equilibria. In some of these, the agents have the power to force delay. They can hold off the principal's overtures temporarily, but they must succumb in finite time. Furthermore, even though the maximal delay does go to infinity as the discount factor approaches one, the (discount-normalized) payoff of the agents must stay below and bounded away from the fully free reservation payoff. It is in this sense that "things [eventually] fall apart" as far as the agents are concerned.

Keywords: Externalities, bilateral contracting, coordination, exploitation.

JEL Classification: L140, D62, C72

Suggested Citation

Genicot, Garance and Ray, Debraj, Contracts and Externalities: How Things Fall Apart (June 2003). Available at SSRN: https://ssrn.com/abstract=472941 or http://dx.doi.org/10.2139/ssrn.472941

Garance Genicot (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-7144 (Phone)
202-687-6102 (Fax)

HOME PAGE: http://www.georgetown.edu/faculty/gg58

Debraj Ray

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10003
United States
212-998-8906 (Phone)
212-995-4186 (Fax)

Autonomous University of Barcelona - Instituto de Analisis Economico (CSIC)

Campus UAB
E-08193 Bellaterra
Spain

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