Handbook of Game Theory and Industrial Organization, Volume II
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Handbook of Game Theory and Industrial Organization, Volume II

Applications

Edited by Luis C. Corchón and Marco A. Marini

This second volume of the Handbook includes original contribution by experts in the field. It provides up-to-date surveys of the most relevant applications of game theory to industrial organization. The book covers both classical as well as new IO topics such as mergers in markets with homogeneous and differentiated goods, leniency and coordinated effects in cartels and mergers, static and dynamic contests, consumer search and product safety, strategic delegation, platforms and network effects, auctions, environmental and resource economics, intellectual property, healthcare, corruption, experimental industrial organization and empirical models of R & D.
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Chapter 10: Strategic delegation in oligopoly

Michael Kopel and Mario Pezzino

Extract

In his book Strategies of Commitment, Nobel Prize winner Thomas Schelling discusses several examples of the functioning of commitment strategies and their importance (Schelling, 2006). The idea is that in an environment of strategic interdependence where each player’s payoff depends on the decisions of all players, a player’s credible commitment to a strategy is important as it shapes rivals’ expectations and thus influences outcomes. For example, when Airbus publicly announced its plans to build the super jumbo jet A380, competitor Boeing dropped the plans to pursue a higher-capacity version of the successful 747 (called the 747X). Arguably, the visible commitment of Airbus has preempted Boeing to further compete in the market for super jumbo jets, a market that is believed to be too small to be profitable for two large-airframe manufacturers. Strategic delegation is an example of strategic commitment. Delegation of decision making is common. Shareholders delegate managerial decisions to experienced chief executive officers (CEOs). Headquarters delegate investment and price or quantity decisions to division managers with local market know-how. Manufacturers delegate marketing decisions to their retailers who are well informed about customer preferences. The main message of the strategic delegation literature is that delegation of decisions to agents with differing objectives can provide benefits to the owners by influencing the expectations and actions of rival firms. This is particularly important in oligopolistic markets where only a limited number of firms compete and the performance of each firm in the market depends on the choices of all firms. In oligopolistic markets, observable transfer of decision rights to agents who are making the choices on behalf of the firms’ principals can yield strategic benefits. For example, delegation allows the firm’s owners to contractually induce the manager to compete more aggressively by selling a higher quantity in the product market than would be sold without delegation. To exploit the benefits from delegation, the principal can strategically influence the delegate’s choices by properly designing compensation contracts, by limiting decision rights, or by adapting the organizational structure. The strategic delegation approach complements the theory of incentives in principal–agent relationships, where the design of contracts or organizational structures serves to minimize the costs of asymmetric information and conflicting interests of the parties.

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