Contracting with asymmetric information in the presence of positive network effects: Screening and divide-and-conquer techniques

This paper shows how pessimistic expectations reduce the e¤ectivity of monopolist screening techniques with positive network e¤ects, and demonstrates how divide-and-conquer strategies may solve the consumers’ coordination problem. In the sequential mechanism, di¤erent expectations about future network sizes become relevant in the incentive constraints of di¤erent consumer types. Screening consumers is less costly in later periods, so pooling may be bene…cial in early stages of contracting. The joint presence of asymmetric information and positive network e¤ects yields a strict downward distortion from the welfare-maximizing quantity scheme, while unique implementation has further downward distorting e¤ects. Keywords : network e¤ects, expectations, screening contracts, divideand-conquer strategies, monotone comparative statics JEL Classi…cation : D42, D62, D82, L12 The author thanks Patrick Rey for motivating discussions, and acknowledges comments from Mark Armstrong, Peter Benczur and seminar audiences at UCL and Keele University. yInstitute of Economics at the Hungarian Academy of Sciences and Central European University. Postal address: Institute of Economics, Hungarian Academy of Sciences, Buda1⁄2orsi út 45, Budapest 1112 Hungary. Phone: +36-1-3092653, fax: +36-1-3193136. E-mail address: [email protected]