Contractual Chains

This paper examines a model in which individuals contract with one another along the branches of a fixed network and then select verifiable productive actions with externally enforced transfers. Special cases of the model include most settings of contracting with externalities that have been studied in the literature. The model allows for a type of externality that the previous literature has not explored — where a party is unable to contract directly with others whose actions affect his payoffs. The paper explores the prospects for efficient outcomes under various contract-formation protocols (“contracting institutions”) and network structures. There are contracting institutions that always yield efficient equilibria for any connected network. A critical property is that the institutions allow for sequential contract formation or cancellation. ∗UC San Diego; http://econ.ucsd.edu/∼jwatson/. Aspects of the work reported here were developed while the author visited Yale in 2010 and the Center for Advanced Study in the Behavioral Sciences (Stanford) in 2012. The author thanks colleagues at these institutions and at UCSD for comments and support.