1 Facolt di Economia U niversit degli Studi di Parma Cooperation and Competition Among Firms Ch. 2 Provisional Version (1) Check List Individual Firm 0135 Economie of Scale Economies of Scope Economies of Specialization Reduction of Transaction Costs Risk sharing Collusion Payoffs Internalization of Esternalities Exploitation of Resource Complementarity Lower Market Incompleteness Check List Expected Gross Benefits of Interfirm Cooperation 0135 Economie of Scale Economies of Scope Economies of Specialization Reduction of Transaction Costs Risk sharing Collusion Payoffs Internalization of Esternalities Exploitation of Resource Complementarity Lower Market Incompleteness Check List Expected Gross Benefits of Acquisition & Merger 0135 Economie of Scale Economies of Scope Economies of Specialization Reduction of Transaction Costs Risk sharing Collusion Payoffs Internalization of Esternalities Exploitation of Resource Complementarity Lower Market Incompleteness Check List Expected Gross Benefits of Check List Gross Expected Benefits Individual Firm Interfirm Cooperation Acquisition&Merger 7 Costs of Cooperation 8 Inequality (1) Collective action is chosen by rational agents when collective benefit (B c ) for each agent (B c /n=B ca ) is higher than benefit from individual action (B ia ): B ca >B ia (1) 9 Cost of individual action (single agent/firm) Interdendence : No Coordination by : Price/Contract/Market Costs: Transaction Costs 10 Costs of cooperation Interdependence: High Coordination by : Administrative structure / Information exchange/ Planning and monitoring/ Incentive and sactioning mechanisms/Enforcing the rules/ Checking opportunist behaviour Costs: Regulation cost /Coordination costs 11 Costs of cooperation Interdependence: High Coordination by : Administrative structure / Information exchange/ Planning and monitoring/ Incentive and sactioning mechanisms/Enforcing the rules/ Checking opportunist behaviour Costs: Regulation cost /Coordination costs 12 Costs of cooperation Interdependence: High Coordination by : Administrative structure / Information exchange/ Planning and monitoring/ Incentive and sactioning mechanisms/Enforcing the rules/ Checking opportunist behaviour Costs: Regulation cost /Coordination costs 13 Inequality (2) (B ca -(C c +C r ))>(B ia -C t ) with C c, C r >0 ; C t 0 where C c = Coordination costs C r = Regulation costs C t = Transaction costs 14 Regulation Costs Set up of incentive and sactioning mechanisms Checking opportunist behaviour Enforcing the rules 15 Invisible Hand Rational (self-interested, opportunistic or not ) individuals, who maximize their utility, increase the collective aggregate welfare of the group A. Smith (WoN): . he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. 16 Social dilemmas Rational individuals, who maximize their utility, may decrease not only the collective welfare, but also their own individual utility.. The Tragedy of the Commons Hardin (1968) The Tragedy of the Commons: The tragedy of the commons develops in this way. Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons. Such an arrangement may work reasonably satisfactorily for centuries because tribal wars, poaching, and disease keep the numbers of both man and beast well below the carrying capacity of the land. Finally, however, comes the day of reckoning, that is, the day when the long-desired goal of social stability becomes a reality. At this point, the inherent logic of the commons remorselessly generates tragedy. The Tragedy of the Commons As a rational being, each herdsman seeks to maximize his gain. Explicitly or implicitly, more or less consciously, he asks, "What is the utility to me of adding one more animal to my herd?" This utility has one negative and one positive component. 1. The positive component is a function of the increment of one animal. Since the herdsman receives all the proceeds from the sale of the additional animal, the positive utility is nearly The negative component is a function of the additional overgrazing created by one more animal. Since, however, the effects of overgrazing are shared by all the herdsmen,the negative utility for any particular decisionmaking herdsman is only a fraction of 1 The Tragedy of the Commons Adding together the component partial utilities, the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another.... But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit -- in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all Hardin:Glass:Ostrom: 21 Social dilemmas Rational individuals, who maximize their utility, may decrease not only the collective welfare, but also their own individual utility. (The source of social dilemmas is self- regarding rationality as well as opportunism). 22 Social dilemmas are situations in which individual rationality leads to collective irrationality. That is, individually reasonable behavior leads to a situation in which everyone is worse off than they might have been otherwise. Many of the most challenging problems we face, from the interpersonal to the international, are at their core social dilemmas (Kollock 1998). Social dilemmas Social dilemma is a situation in which: (1) two or more individuals can behave so as to maximize personal interests or maximize collective interests, but (2) if all be- have so as to maximize personal interests all are worse off than if all behave so as to maximize collective interests (Komorita & Parks 1994) 23 Social dilemmas Social dilemmas are situations in which each member of a group has a clear and unambiguous incentive to make a choice that - when made by all members - provides poorer outcomes for all than they would have received if none had made the choice. Thus, by doing what seems individually reasonable and rational, people end up doing less well than they would have done if they had acted unreasonably or irrationally (Dawes & Messick 2000) 24 As individuals we are each better off when we make use of a public resource, such as public television, without making any contribution, but if everyone acted on this conclusion, the public resource would not be provided and we would all be hurt. Each farmer does best by taking as much irrigation water as possible, and each fisher benefits from catching as many fish as possible, but the aggregate outcome of these individually reasonable decisions can be disaster (groundwater exhausted and fish species depleted to the point of extinction) (Kollock 1998). 25 Social dilemmas 26 Examples of social dilemmas Supply of public goods Exploitation of technological externalities Collusion Exploitation common pooled resources, ecc. 27 Typologies of social dilemmas Social Traps Public Goods 28 Social traps Maximizing short term benefit leads to a reduced long term benefit 29 On the other hand, adopting a course of action that reduces short term benefit (without canceling it) can prevent the initial benefit from being replaced by a later disadvantage (eg, common pooled resources) Social traps 30 Public Goods Supporting a cost in the short term produces a benefit in the long term. 31 Public Goods Supporting a cost in the short term produces a benefit in the long term. Refusing to bear the cost in the short term results in a more than proportional loss in the long run(eg. Environment safeguard). 32 The structure of social dilemmas: the prisoners dilemma 33 The cartel Firm F1 and F2 are part of a cartel of producers. Payoff of different course of action are perfectly known by the parties 34 Fearing the intervention of the antitrust authoritiy, they give up to the mechanism of exchange of information that until then had ensured the coordination of their choices in terms of output (or price) supplied on the market. 35 Alternatives: cooperate (continuing with the cartel, share the monopoly profits); defect (exiting the cartel, lower prices, increase their market share and enhance profits at the expense of the other firm). 36 Outcome 1 Both companies cooperate, and their profits are equal to 4 (upper left quadrant) 37 4,4 C D C D F2F2 F1F1 Cooperation 38 4,4 C D C D F2F2 F1F1 Cooperation 39 Outcome 2 Firm F1 defects, while F2 cooperates. F1 obtains profits equal to 8 and F2 equal to 0 (lower left quadrant) 40 C D C D F2F2 F1F1 8,0 Defection of F 1 41 C D C D F2F2 F1F1 8,0 Defection of F 1 42 Outcome 3 Firm F2 defects, while F1 cooperates. F2 obtains profits equal to 8 and F1 equal to 0 (upper right quadrant) 43 C D C D F2F2 F1F1 Defection of F 2 0.8 44 Outcome 4 Both firms defect and get profits equal to 2 (lower right quadrant) 45 C D C D F2F2 F1F1 Defection of F 1 and F 2 2.2 46 C D C D F2F2 F1F1 Prisoners dilemma 2.2 4,4 0,8 8,0 47 Comparison between payoffs F 1 compares his own payoff to F 2 s choices. 48 C D C D F2F2 F1F1 2.2 Prisoners dilemma 4,4 0,8 8,0 49 If F 2 cooperates, the rational choice for F 1 will be: C D C D F2F2 F1F ,4 0,8 8,0 50 If F 2 defects, the rational choice for F 1 will be C D C D F2F2 F1F1 2,22,2 4,4 0,8 8,0 51 F 2 compares his own payoff to F 1 s choices 52 C D C D F2F2 F1F1 Prisoners dilemma 2.2 4,4 0,8 8,0 53 If F1 cooperates, the best choice for F 1 will be: C D C D F2F2 F1F1 2,22,2 4,4 0,8 8,0 54 If F1 defects, the best choice for F 1 will be: C D C D F2F2 F1F1 2,22,2 4,4 0,8 8,0 55 Selected Payoff : C D C D F2F2 F1F1 2,22,2 4,4 0,8 8,0 56 Considering it likely that the counterpart intends to maximize its benefit, both firms decide to defect in order to minimize their losses C D C D F2F2 F1F1 2,22,2 4,4 0,8 8,0 57 Individually rational choices lead to collectively and individually irrational outcomes. (D,D=2,2R>P>S (8>4>2>0) 63 Violations of assumptions If R = P, joint defection (P, P) shows no conflict between individual rationality and collective rationality;. 64 C D C D F2F2 F1F1 Prisoners dilemma 4,4 0,8 8,0 65 C D C D F2F2 F1F1 Prisoners dilemma 4,44,4 4,4 0,8 8,0 66 Violations of assumptions If T = R, there will be no incentive to defect;. 67 C D C D F2F2 F1F1 Prisoners dilemma 2.2 8,8 0,8 8,0 68 C D C D F2F2 F1F1 Prisoners dilemma ,88,8 0,8 8,0 69 Violations of assumptions If P = S there will be more then one equilibrium and the final outcome remains unknown. 70 C D C D F2F2 F1F1 Prisoners dilemma 2.2 4,4 2,8 8,2 71 C D C D F2F2 F1F1 Prisoners dilemma ,4 2,82,8 8,28,2 72 Cooperation and the payoff structure 73 The higher the prize (R), the greater the likelihood that agents will continue to cooperate; The higher the value of the payoff of the punishment for mutual defection (P), the greater the likelihood that agents defect during the game; The level of payoff (Experimental economics) 74 Where an agent defects and the other cooperates (C, D or D, C ): the lower (S) is, the greater the probability that the cooperator will defect in the next round of the game; the greater (T) is, the greater the likelihood that the defector will continue to defect. 75 Impact of the payoff structure (T-R), p(c) (R-P), p(c) (P-S), p(d) 76 K (Cooperation) Index K=(R-P)/(T-S) (Rapoport 1967) 77 Postulates a)when the benefits of individual defection (T) are particularly high, cooperation can be pursued only if R turns out to be much higher than P; b)when R is similar to P, the likelihood of cooperation is high only if P is low and slightly higher than S. 78 Cooperation and the Role of Communication 79 Communication and the likelihood of cooperation In a game theory context: no effect 80 Communication and the likelihood of cooperation In an experimental economics context: Dawes, McTavish and Shaklee (1977): a)No communication among interacting agents; b)Communication on the characteristics of the players and issues not directly connected to the game; c)Communication on issues relevant to the game; d)Notification of intention of the agents without binding commitments. 81 Communication and the likelihood of cooperation Cooperation rate of A=B=28 Cooperation rate of C=D=68. 82 Explanation Effects of communication on : 1) interpersonal trust; 2) humanization of the group 3) individual identity; 4) understanding of the game; 5) collective identity of the group; 6) public commitments. 83 Cooperation and the Group Size (Number of Participants) 84 Cooperation and the Group Size Too many cooks spoil the broth 85 Cooperation and the Group Size Too many cooks spoil the broth In a game theory context: no effect 86 The Prisoners Dilemma from 2 to N agents C D C D B A 1, 1 3/2, 3/21/2, 2 2, 1/2 87 Payoff Matrix 88 Likelihood of Cooperation and Group Size P(c) No. agents 89 Interpretative hypotheses of the (inverse) relationship between group size and willingness to cooperation Bad apples 90 Interpretative hypotheses of the (inverse) relationship between group size and willingness to cooperation Bad apples Interpersonal control Hume's Treatise: Two neighbors may agree to drain a meadow, which they possess in common; because 'tis easy for them to know each others mind, and each may perceive that the immediate consequence of failing in his part is the abandoning of the whole project. But 'tis difficult, and indeed impossible, that a thousand persons shou'd agree in any such action... 91 Interpretative hypotheses of the (inverse) relationship between group size and willingness to cooperation Bad apples Interpersonal control Effectiveness of individual action Social Dilemmas and Regulation Costs (Parkhe 1993) : The performance of a strategic alliance will be negatively related to the extent to which the parties perceive each other as behaving opportunistically The extent of the perception of opportunistic behavior and the level of contractual safeguards embedded in a strategic alliance will be positively related. Social Dilemmas and Regulation Costs At the firm level: Set up of internal mechanism of detecting opportunism Writing contractual safeguards Legal protection of industrial knowledge Conflict prevention and management (Hostages) Sanctioning procedures Modify the payoff structure Set up and management of government devices etc. 94 Inequality (2) (B ca -(C c + C r ))>(B ia -C t ) with C c, C r >0 ; C t 0 where C c = Coordination costs C r = Regulation costs C t = Transaction costs 95 Coordination Costs 96 Coordination Game (1) Battle of the Sexes F B F B Paola Paolo 1, 3 3, 10, 0 F=Football Match B=Ballet 97 Coordination Game (1) Battle of the Sexes F B F B Paola Paolo 1, 3 3, 10, 0 F=Football Match B=Ballet 98 Dimensions of the coordination problems: 1)the constraints that agents assume, by contract or by convention, to avoid conflicting decisions. 2) the procedures to identify a single equilibrium solution among different alternatives; 99 Main characteristics of the coordination problems (in comparison with PD) : 1)Information vs opportunism; 2) More than one equilibrium. 100 Coordination Game (2) Costs related to: information investment, knowledge transfer, comparison between feasible alternatives; singling out the best course of action negotiating investments ; adjustment of individual conduct to the general course of action (modifying individual plans, accomplishing time and space constraints (synchronization)) 101 Coordination Game (2) P M P M A2A2 A1A1 3, 3 2, 2 102 Coordination Game (2) P M P M A2A2 A1A1 3, 3 2, 2 103 Coordination Game (2) P M P M A2A2 A1A1 3, 3 2, 2 104 Coordination Game (2) P M P M A2A2 A1A1 3, 3 2, 2 Coordination Game (2) https://www.youtube.com/watch?v=2sT_zaofuuE 106 Coordination Game (3) Stag Hunt Game (Assurance Game) Jean-Jacques Rousseau Jean-Jacques Rousseau StagHare Stag Hare A2A2 A1A1 1, 1 2, 20, , 0 107 Rousseau in A Discourse on Inequality: If it was a matter of hunting a deer, everyone well realized that he must remain faithful to his post; but if a hare happened to pass within reach of one of them, we cannot doubt that he would have gone off in pursuit of it without scruple..." 108 Coordination Game (3) Stag Hunt Game (Assurance Game) Jean-Jacques Rousseau Jean-Jacques Rousseau StagHare Stag Hare A2A2 A1A1 1, 1 2, 20, , 0 109 Coordination Game (3) Stag Hunt Game (Assurance Game) StagHare Stag Hare A2A2 A1A1 1, 1 2, 20, , 0 110 Coordination Game (4) T M T M A2A2 A1A1 3, 4 4, 32, 1 111 Coordination Game (3) T M T M A2A2 A1A1 3, 4 4, 32, 1 112 Coordination Difficulties (van Huyck, Battalio and Beil 1990) 113 Dimensions of the coordination problems: 1)the constraints that agents assume, by contract or by convention, to avoid conflicting decisions. 2) the procedures to identify a single equilibrium solution among different alternatives; 3)the containment of the risk that, owing to strategic uncertainty, suboptimal equilibria will be chosen. Ranking of the importance of specific factors for strategic alliances Clearly understood roles Communication between partners Clearly defined objectives Relationships building Thorough planning Frequent performance feedback Clear payback timelines Integration of information system 115 (1) Assumption of imperfect information If the economic and technological content of the goods to be produced is not known to the agents, there emerges a new constraint to collective action: before starting the production of the collective good, agents must decide which among different alternatives should be taken. 116 (1) Assumption of imperfect information Most of the projects carried out in the present have only partial similarities with those carried out in the past (Different technology, different availability of resources, changes in individual preferences, group size, etc.). 117 (1) Assumption of imperfect information Hence obstacles to collective action consist of information and decision costs that individual agents have to sustain to identify which goods should be produced as well as uncertainty on the distribution of net benefits 118 (2)Multipliplicity of equilibria Collective action has its origin in the strategic complementarity which exists between the individuals who take part ('individual agents are more productive the higher the production level of other agents' (Cooper and Johri, 1996). N C AC C Coord N C AC C N2 N C AC C N2N3 N C AC C N2 N3 N C TC C N2 N3 AC 124 (2)Multipliplicity of equilibria The existence of complementarity, on the one hand, determines incentive to collective action and justifies the greater efficiency of the choice of cooperative rather than individual action. On the other hand, it is the source of a multiplicity of equilibria. In fact, as we will see, the greater the size of the group of participants, the greater the value of its contribution and the more alternative technologies available, the wider the range of possible solutions. 125 126 127 128 129 130 131 132 The starting of collective action The goods to be made become known only after the agents have organized the alternatives and have managed to identify the optimum solution (of the many possible ones). The equilibrium selected will determine the amount of the individual investment (or its cost), the size of the group of participants and the technology. Only then will possible sanctions for non- observance of the agreement be decided and the production process start. The starting of collective action Even before control of the risks of free riding, collective production of a good appears to be influenced by the costs of the search for the most efficient solution and the alignment of individual agents' plans to a single general plan (costs of co-ordination). The beginning of collective action In logical time (and often in historical time) the failure of collective action depends firstly on co-ordination failure and secondly on benefit redistribution conflict. The problem of co-ordination is met before the control of opportunism and the seriousness of the problem appears to be independent of the entity of the second. In fact, if we had significant co-ordination costs and absence of opportunism, the level of co-ordination costs would nevertheless remain high and the likelihood of non- production would also be significant. 136 Types of coordination costs (information and decision making costs) Negotiating costs Synchronization costs Selection costs Negotiating costs Known 138 Synchronization costs Cost of formalizing a convergent and simultaneous decision. Arising from: degree of anomie informational barriers (eg. distortions in the communication, ambiguity in the signals, physical distance); division of labor and role specialization. 139 Selection costs Costs of identifying the optimal equilibrium Arising from: acquisition and transfer of information between the relevant players; adaptation of knowledge possessed by the players to the skills useful for the assessment of individual plans; identification and sorting workable options (equilibria). 140 Inequality (2) (B ca -( C c +C r ))>(B ia -C t ) with C c, C r >0 ; C t 0 where C c = Coordination costs C r = Regulation costs C t = Transaction costs Individual Firm 0135 Economie of Scale Economies of Scope Economies of Specialization Reduction of Transaction Costs Risk sharing Collusion Payoffs Internalization of Esternalities Exploitation of Resource Complementarity Lower Market Incompleteness Check List Expected Gross Benefits of Interfirm Cooperation 0135 Economie of Scale Economies of Scope Economies of Specialization Reduction of Transaction Costs Risk sharing Collusion Payoffs Internalization of Esternalities Exploitation of Resource Complementarity Lower Market Incompleteness Check List Expected Gross Benefits of Acquisition & Merger 0135 Economie of Scale Economies of Scope Economies of Specialization Reduction of Transaction Costs Risk sharing Collusion Payoffs Internalization of Esternalities Exploitation of Resource Complementarity Lower Market Incompleteness Check List Expected Gross Benefits of Individual Firm 0135 Transaction costs : Singling out the minimun price in the market Transaction costs : Negotiating the safeguards Transaction costs : Writing a contract Check List Costs of Interfirm Cooperation 0135 Regulation costs Negotiating costs Synchronization costs Selection costs Check List Costs of Acquisition & Merger 0135 Transaction costs : Singling out the minimun price in the market Transaction costs : Negotiating the safeguards Transaction costs : Writing a contract Check List Costs of