Contractual Pricing with Incentive Constraints

Extending the notion of contractual pricing introduced by Makowski and Ostroy (2003) to economies with moral hazard, this paper develops a model of team formation and organized competition with three main contributions. Firstly, a team’s organization is defined as an allocation of (public or private) commodities together with incentive compatible actions and information to its members. Secondly, a version of price taking equilibrium is proposed to formalize the idea that individuals compete to play games, and that both the games being played as well as the (incentive compatible) outcome of those games are determined competitively. This yields a general equilibrium foundation for efficient correlated equilibrium. Finally, our approach is contrasted with the recent theory of clubs, with emphasis on differences in the nature of prices for team versus club membership that lead to incentive efficiency. Specifically, anonymous pricing of jobs within clubs fails to decentralize incentive efficient allocations in the presence of binding incentive constraints. JEL Classification: C72, C78, D41, D51.