Communicating Vertical Hierarchies: the Adverse Selection Case

Salvatore Piccolo ()

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: I study the rationale for information sharing in a model where two principals, which exert production externalities one on another, endogenously decide whether to exchange information about their exclusive agents. I show that one novel effect shapes communication decisions when agents are privately informed about production costs. This effect is absent under complete information and it turns out to be of first-order magnitude relative to those emerging in such benchmark. Roughly, what matters is how sharing information impacts contracting relationships within opponent organizations, and therefore its effect on equilibrium outputs. Information exchange induces strategies to be correlated via the distortions channel. Because of those distortions, the equilibrium value of communication depends on the interplay between the nature of upstream externalities and the sign of cost correlation. When upstream externalities and cost correlation have the same sign, there exists a unique symmetric equilibrium with no communication. By contrast, when upstream externalities and cost correlation have opposite signs there exists a unique symmetric equilibrium where both principals share information. I also show that, unlike in previous models, under asymmetric information principals might run into a prisoner dilemma when there is no communication at equilibrium. Information sharing is also shown to have an unambiguous negative effect on rents. Moreover, there exists a system of transfers such that the equilibrium outcome obtained when both principals share information is collusion-proof.

Keywords: Adverse selection; communication; information sharing; vertical hierarchies (search for similar items in EconPapers)
Date: 2011-02-09
New Economics Papers: this item is included in nep-bec, nep-cis and nep-cta
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Citations: View citations in EconPapers (1)

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