Indirect evolution vs. strategic delegation: a comparison of two approaches to explaining economic institutions

Transcription

1 European Journal of Poltcal Economy Vol Indrect evoluton vs. strategc delegaton: a comparson of two approaches to explanng economc nsttutons Martn Dufwenberg a,b,), Werner Guth c a CentER for Economc Research, Tlburg nõersty, Tlburg, The Netherlands b Department of Economcs, ppsala nõersty, Sweden c Department of Economcs, Humboldt nõersty, Berln, Germany Receved 1 November 1997; receved n revsed form 1 March 1998; accepted 1 July 1998 Abstract Two major methods of explanng economc nsttutons are compared for the case of a homogenous quadratc duopoly market. In the ndrect evolutonary approach, sellers may evolve to care for sales, n addton to proft. In the strategc delegaton approach, sellers may desgn ncentves so that ther agents care for sales. The two approaches model dfferent phenomena, but both allow certan knds of commtment. We nvestgate under what crcumstances the two approaches lead to smlar market outcomes. The results underscore the techncal smlartes as well as the conceptual dfferences between the two approaches. q 1999 Elsever Scence B.V. All rghts reserved. JEL classfcaton: C7; D1; D43 Keywords: Indrect evoluton; Strategc delegaton; Commtment; Duopoly market; Agency theory 1. Introducton For a gven nsttutonal desgn, one often can derve results concernng the nature of strategc nteracton by applyng tools of game theory. However, the bulk ) Correspondng author. Department of Economcs, Stockholm nversty, Stockholm, Sweden. Tel.: q ; Fax: q ; E-mal: md@ne.su.se r99r$ - see front matter q 1999 Elsever Scence B.V. All rghts reserved. PII: S

2 8 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) of economc analyss does not address the queston of why certan nsttutons preval. Ths study compares two methods of explanng nsttutonal desgns, nstead of assumng nsttutonal desgn as exogenously gven. The frst approach, to whch we refer as strategc delegaton, has a long standng tradton n the socal scences. People do not only decde wthn certan nsttutons, but they decde upon nsttutonal desgn. A famous example s, for nstance, the contrat socal Ž Rousseau, 176., whch s often referred to when justfyng consttutonal desgn. Clearly, such a contract s only a fcton. There are, however, more realstc examples, for example when legal rules are changed by qualfed majortes, for nstance, by unanmous approval. More specfcally, let an nsttutonal desgn be represented by the rules of a fnal subgame and assume that earler choces n the game allow us to rule out certan subgames. The soluton of the game not only determnes behavor n fnal subgames, but also the choce of subgames,.e., nsttutonal choce. In the case of strategc delegaton, the fnal subgame s characterzed by the motvaton structure of the nteractng agents, and prncpals strategcally desgn the ncentves of ther agents. The second method we consder s the ndrect evolutonary approach, n whch an eõolutonarly stable nsttutonal desgn s derved va evolutonary rather than strategc consderatons. More specfcally, an ndrect evolutonary analyss frst determnes the soluton for any nsttutonal arrangement, and then selects from varous such structures n an eõolutonary model wth nsttutonal desgn constellatons as mutants. We compare the two approaches of strategc delegaton and ndrect evoluton for the case of a smple duopoly where sellers on a homogenous goods market mght care about sales n addton to profts. Strategc delegaton requres a team consstng of a prncpal and hs agent, whereas under ndrect evoluton sellers may themselves evolve to develop an evolutonarly stable concern for sales. The two approaches are conceptually very dfferent. Whereas under strategc delegaton nsttutons are chosen, wth the ndrect evolutonary approach decson or game theory s restrcted to predctng the choce behavor wthn a gven nsttutonal setup. Moreover, strategc delegaton nvolves a rcher socal settng than does the ndrect evolutonary approach, snce strategc delegaton ncludes agents who are absent n the other approach. For these reasons, one mght suspect the two approaches wll lead to very dfferent results. There s, however, also a smlarty between the two approaches. Modelng evoluton by specfyng a Ž geno. type space and an evolutonary dynamcs or a statc evolutonary stablty concept guaranteeng dynamc stablty Žsee Hammersten and Selten, 1994 as well as Webull, poses a challenge smlar to that of modelng the overall game n strategc delegaton. In each case, a certan knd of commtment s nvolved. nder strategc delegaton the prncpal may commt to a partcular behavor by desgnng approprate ncentves; under ndrect evoluton the players preferences are shaped by evoluton, and these preferences may

3 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) serve as commtment devces. 1 Therefore, one may be led to suspect that the two approaches should yeld smlar results. We frst nvestgate a benchmark model of ndrect evoluton n whch sellers may evolve to care for sales n addton to profts. We show that a pure preference for proft maxmzaton s not evolutonarly stable and that the market outcome s more compettve than wth pure proft maxmzaton. We then analyze a model of strategc delegaton n whch the class of feasble contracts s closely comparable to the mutant space under ndrect evoluton. We show that t generates the same market outcome as does the model of ndrect evoluton, despte the prncpals carng for proft only. Ths result ndcates a way n whch one may thnk of ndrect evoluton as correspondng to a specal form of strategc delegaton. In ths sense, our analyss underscores the smlarty between the two approaches. However, f one thnks of natural knds of strategc delegaton contracts that allow for an nduced concern for sales, then other sets of feasble contracts may come to mnd. We look at one such set. At frst glance, one may suspect that the same result as before wll come about, but we show that a dfferent outcome obtans. Ths fndng underscores the conceptual dfferences between the two approaches. If the mutant space of the evolutonary model s natural n that settng, whle the alternatve set of strategc delegaton contracts s natural wth strategc delegaton, then the outcome s senstve to whether the market nsttuton s shaped by evoluton or by desgn. In Secton, we specfy the basc features of the market model we analyze throughout. In Secton 3, we present the model of ndrect evoluton, and compare the outcome to the standard model. In Secton 4, we consder strategc delegaton when agents may be nduced to care for sales, and show that wth an approprate restrcton on the set of feasble contracts the same market outcome results as under ndrect evoluton. Secton 5, studes strategc delegaton wth a dfferent set of feasble contracts for nducng a concern for sales, and shows that the market outcome changes. In Secton 6, we comment on how our results are affected f preference parametersrcontracts are not observable. Secton 7 concludes.. The market model We consder a smple homogenous duopoly market a` la Cournot Ž Sellers s 1, smultaneously choose ther sales amounts x G 0. Assumng a lnear 1 Ths observaton explans why applcatons of the ndrect evolutonary approach sometmes prompt questons whether the ndrect evolutonary approach s the same as the strategc delegaton approach. The typcal argument made s that n a socal dlemma stuaton, due to the scope for ndvdual opportunsm, cooperatve results can be assured by commtments Žnot to behave opportunstcally. and that strategc delegaton and ndrect evoluton provde just two stores how such commtments may result.

4 84 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) demand functon and normalzng t approprately allows us to wrte seller s revenue as x P 1yx yx for s1, and /j. 1. j The market prce s Ž 1yx yx. j. We do not a pror exclude the possblty of negatve prces, but such outcomes wll n fact not be vable under ether of the two approaches to be dscussed. The costs of producton are assumed to be gven by 1r cx qc wth c, C)0.. Accordng to the structural relatonshps 1. and., the market s symmetrc. The proft p Ž x, x. j of seller s1, for sales amounts x and x j wth /j s determned by p Ž x, x. sx 1yx yx y1r cx yc. 3. j j Let us fnally recall the usual results for ths market. For s1,, equlbrum sales, prce and profts can be derved as 1 x s 3qc 4. 1qc ps 3qc 5. c 1q p Ž x, x j. s yc. 6. Ž 3qc. 3. Indrect evoluton The ndrect evolutonary approach allows endogenous dervaton of the rules of the game Ž see Guth and Yaar, 199., and t can therefore be vewed as a way to generalze neo-classcal theory whch tradtonally takes such rules to be exogenously determned. In drect evolutonary analyss or usual evolutonary game theory, one assumes behavor to be genetcally determned Žsee Hammersten and Selten, 1994 for a survey. or acqured phenotypcally va learnng or by cultural evoluton Ž see, for nstance, Boyd and Rcherson, We, however, do not study the evoluton of behavor drectly. Rather a more basc feature of the game, n our case preferences, s the object of evoluton. Ratonal behavor s taken for

5 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) granted, but behavor may nevertheless be ndrectly affected should preferences change. If n a blateral encounter behavor may be guded by an addtonal ncentve, one frst solves all the games resultng from such ncentves for both players. sng these results, one then defnes an evolutonary model wth the possble ncentves as strateges or mutants, and derves the evolutonarly stable ncentve constellaton IncentÕes for sales It s often clamed that sellers are not only nterested n ther profts, but also n ther prestge as sellers Ž see for example Wllamson, Such prestge can be measured by sales Ž quantty amounts.. 3 In general, there may be many ways to nclude such a concern for the quantty sold. Here, we wll rely on the most smple way of dong so, namely by specfyng utltes už x, x j. sp Ž x, x j. qbx Ž 3.1. where p Ž x, x. s as defned by Eq. 3. j, and where bgr s a constant whch measures s predsposton to care for sales. We refer to b as seller s concern for sales. The man restrcton of Ž 3.1. s that t combnes s concerns for profts and sales n an addtve way. The frst step of our ndrect evolutonary analyss requres us to determne the market results for all Ž b,b. 1 constellatons, not necessarly wth b1sb. Wth the help of these results, we then defne an evolutonary game wth mutantsrstrateges b1 and b. The success of a mutant s measured by the proft t makes. 4 Determnng an evolutonarly stable mutant thus answers the queston whether and to what extent sellers evolve n such a way that they care for sales n addton to profts. For the same type of Ž duopoly. market envronment, Bester and Guth Ž analyzed whether altrusm s evolutonarly stable whereas Guth and Huck Ž allow for all possble quadratc proft functons and show that monopolstc competton Ž n the sense of neglectng mutual dependency. can be stable. 3 Snce profts are usually prvate nformaton whereas sales are often wdely known, t s much more lkely that the prestge of a seller depends on sales rather than on profts. Larger sales often requre large producton amounts and thereby an ncreased or more stable use of the labor force, suggestng that a concern for sales mght result from more basc nterests. 4 For genetcal evoluton ths, s rather obvous: The materal success s monotoncally related to reproductve success n the sense of the expected number of offsprng. In case of cultural evoluton Ž Boyd and Rcherson, 1995., the justfcaton s that adaptaton should depend on nterpersonally observable success measures lke proft, and not on ndvdual satsfacton measures whch cannot be observed by others and do not matter for them.

6 86 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) Market nteracton wth a drect concern for sales Our model has been chosen to smplfy the dervaton of market equlbra. From and E u Ž x, x j. s1qb y Ž qc. x yx j s0 Ž 3.. Ex E už x, x j. syž qc. -0 Ž 3.3. Ex for s 1, and j/, one derves equlbrum sales amounts as functons of Ž b,b. 1 : 1qcybjq Ž qc. b x sx Ž b,bj. s. Ž 3.4. Ž 1qc.Ž 3qc. Note that we use x both to refer to a specfc optmum choce of x for gven preference parameters, and to refer to the functon descrbng ths connecton. In many cases below, we make an analogous use of notaton because ths smplfes the presentaton greatly The eõolutonary model If one nserts the soluton Ž 3.4. nto the proft functon 3. one can derve each frm s proft as a functon of Ž b, b. and obtan for s1, wth j/ 1 Ž j. Ž j. Ž. p b,b sx 1yx yx y1r c x yc. 3.5 Eq. Ž 3.5. s a proft functon expressng market success as a functon of the possble ncentves for sales. We refer to Eq. Ž 3.5. as the seller s reproductve success from the ncentve constellaton Ž b, b. j. By Gs Ž M, p. Ž 3.6. wth M Ž the mutant space. equal to R Ž the set of real numbers., and p defned by Eq. Ž 3.5. for all possble ncentve constellatons b, bjg M we have defned an evolutonary model whose evolutonarly stable strateges we now wsh to determne The eõolutonarly stable concern for sales An evolutonarly stable concern for sales can be defned as an evolutonarly stable strategy Ž ESS. of the evolutonary model defned n Ž Thus, b s an ESS f p Ž b,b. Gp Ž b,b. ;bgm Ž 3.7.

7 M. Dufwenberg, W. Guthr European Journal of Poltcal Economy 15 ( 1999) and f p Ž b,b.)p Ž b,b. ;bg M such that p Ž b,b. s p b,b. Ž 3.8. For the case at hand, t suffces to look at condton Ž 3.7., snce the best reply s unque n every symmetrc equlbrum Ž b, b. of the symmetrc evolutonary model G. From E p Ž b,bj. s 0 Ž 3.9. Eb E Eb p b,b -0 Ž j as well as from bs b j, one obtans 1 b s b Ž c. s. Ž q 5cq c Note that b )0. A pure preference for proft maxmzng behavor,.e., bs 0, s not promoted by evolutonary forces. Only for extremely large values of c wll the market evolve n such a way that sellers do not care for sales drectly. When c 0 the parameter b Ž c., expressng a drect concern for sales n the sense of the utlty functon Ž 3.1., ncreases to 1r The market outcome under ndrect eõoluton The market outcome under ndrect evoluton can be determned by nsertng b s b s b nto Eq. Ž 3.4. j. For s 1,, equlbrum sales, prce and profts can be derved as 1q b 6q 5cq c x s s Ž q c Ž 3q c.ž 5q 5cq c. 3q 5cq c q cž 5q 5cq c. p s Ž Ž 3q c.ž 5q 5cq c. c j p Ž x, x. s p x y Ž x. y C. Ž We now compare the sales gven here wth those obtaned n the standard Cournot model of Secton. From Ž 3.1. and 4., we derve x 6q 5cq c s Ž x 5q 5cq c showng that the market results from ndrect evoluton are more compettve than n the standard Cournot model. Ths relaton wll, furthermore, ncrease when c

8 88 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) becomes smaller and dsappears when c `. It s straghtforward to show that the prce and the proft levels Ž under ndrect evoluton are lower than n the standard Cournot model We summarze the fndngs of Secton 3 as follows. Theorem 1. If n a symmetrc market wth profts (.3 ), sellers can deõelop ncentões of the form ( 3.1) and f the ncentões of both sellers are commonly known, the only eõolutonarly stable drect concern for sales s b, defned by Eq. ( 3.11 ). The market outcome, gõen by ( ), wll be more compettõe than n the standard Cournot model. 4. Strategc delegaton In ths secton, we nvestgate the consequences of lettng sellers nduce a concern for sales va strategc delegaton, restrctng the set of feasble contracts so as to correspond closely to the mutant space of the prevous secton. We show that the same market outcome as under ndrect evoluton results. Strategc delegaton reles on a rcher socal structure of the market than ndrect evoluton. The two seller frms, j s 1, wth / j are now to be represented by two teams Ž P, A. and Ž P, A. j j of prncpals P and Pj and ther respectve agents. Strategc delegaton 5 typcally takes the form that frst, the two prncpals propose contracts whch then, f accepted by the agents, gude behavor n the market. From now on, we presume that agents always accept ther contracts, but that these contracts must net each agent zero payoff n the end Žn subgame perfect equlbrum.. By rggng the model approprately, ths can be justfed by assumng outsde optons of zero worth for the agents, and presumng that each prncpal makes a take-t-or-leave-t offer to hs agent. Snce agents wll make zero payoff, whatever proft s generated n the market goes to the prncpals. Ths facltates a clear-cut comparson between the outcomes under strategc delegaton and ndrect evoluton. Suppose each prncpal s restrcted to propose a contract of the form Ž G, b. wth G, bgr Ž 4.1. that determnes agent s payoff as u Ž x, x. sg qx 1yx yx qb x y1r cx yc. Ž 4.. j j We refer to G, a drect transfer from the prncpal to the agent Ž whch may be negatve., as agent A s salary. Ths transfer has no effect on the agent s 5 Dfferent aspects of strategc delegaton have been analyzed by Fershtman and Judd Ž 1987., Fershtman and Kala Ž n press., Fershtman et al. Ž 1991., Green Ž 1990., Katz Ž 1991., Rotemberg Ž 1994., Callaud et al. Ž 1995., Gal-Or Ž and Bak and Km Ž For an expermental study, see Fershtman and Gneezy Ž

9 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) ncentves, but t puts all the barganng power n the hands of the prncpal. Snce the agent can earn only zero outsde the frm, the prncpal can reap all profts avalable, just lke n the evolutonary model where no agent was present. We refer to b as A s sales ncentões. Whereas under ndrect evoluton the sellers could evolve so as to care for sales n addton to profts, now prncpals can nduce smlar concerns for sales n ther agents by approprate choces of b. Prncpal P s motvated to extract as much payment as possble from hs agent s actvty, and hence to choose Ž G, b. so as to maxmze R syg yb x. Ž 4.3. We solve the model for a subgame perfect equlbrum usng backwards nducton: For gven choces of contracts, each agent wll choose sales so as to maxmze Ž 4... The relevant condtons match those gven n Ž 3.. and Ž 3.3., so the sales decson wll be as gven by Ž In any subgame perfect equlbrum, each prncpal takes ths behavor as gven and choose a contract Ž G, b. whch s optmal gven the other prncpal s choce of contract. Frst, G should be chosen so that Ž 4.. s equal to zero. Substtutng from Ž 3.4. n Ž 4.., and then substtutng the optmal value for G n Ž 4.3. shows that Ž 4.3. can be replaced by Ž Hence, each prncpal s choce of b must be gven by Ž 3.9. and Ž for each s 1,. Careful nspecton of Ž 3.9. and Ž Ž reveals that there cannot be any asymmetrc equlbra b, b. 1 wth b 1 / b. The subgame perfect equlbrum choces of b are unque and gven by b as gven n Ž The followng theorem summarzes these fndngs. Theorem. Strategc delegaton n the form of ( 4.1 ) results n contracts ( G, b ) wth sales ncentões b, defned by Eq. ( 3.11 ). Sales, prces, and profts wll be gõen by ( ). Hence, the same market outcome results as under ndrect eõoluton. 5. Strategc delegaton wth a dfferent set of feasble contracts The set of strategc delegaton contracts that are feasble under 4.1 tghtly correspond to the mutant space allowed under the ndrect evoluton approach of Secton 3. Hence, the results of Secton 4 ndcate a way n whch one may thnk of ndrect evolutonary as correspondng to a partcular form of strategc delegaton. However, strategc delegaton that allows for a concern for sales to be nduced may take many forms not allowed n Secton 4. In ths secton, we consder another set of feasble contracts whch may seem natural. At frst glance, one may thnk that the same market outcome as n Secton 4 wll obtan. We show that ths s not the case though. Ths fndng underscores the conceptual dfferences between the ndrect evolutonary approach and the approach of strategc

10 90 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) delegaton. Whle there are techncal smlartes between the two approaches that under certan crcumstances lead to smlar outcomes, when each approach s set up and motvated ndependently, there s no reason to beleve they lead to the same outcome. Suppose each prncpal s restrcted to propose a contract of the form Ž G, b. wth G, bgr Ž 5.1. wth payoff to agent gven as už x, x j. sgqbx y1r cx yc. Ž 5.. Espressons Ž 5.1. dffers from Ž 4.1. n that the agents do not care at all about revenue. As wth Ž 4.1., prncpals may develop a concern for sales va ther agents. To determne the results of strategc delegaton, one smply has to solve the two-stage game for the subgame perfect equlbrum Ž whch agan s unque.. Frst, prncpals choose contracts as descrbed n Ž 5.1. and then, knowng both contracts, each agent s 1, chooses x to maxmze Ž 5... When choosng a contract Ž G, b. prncpal P maxmzes R sx 1yx yx yg yb x. Ž 5.3. j It can be easly seen that the agents face ndependent maxmzaton tasks. More specfcally, the payoff u Ž x, x. j depends only on x and not at all on x j. Maxmzaton of u Ž x, x. as defned by Ž 5.. by choce of x yelds j x q sb rc for s1,. Ž 5.4. Prncpal P wll choose G such that the agent s payoff wll be zero. Insertng Ž 5.4. nto Eq. Ž 5.. and settng u s 0 yelds b q q G sg b scy for s1,. 5.5 c Insertng 5.4 and 5.5, all these values, nto 5.3 results n b b q R Ž b,bj. s Ž cybybj. y yc Ž 5.6. c c for, js1, and /j. Snce due to the defnton of G q Ž b., partcpaton of the agent s guaranteed, prncpal P can desgn an optmal contract Ž G, b. by maxmzng R q Ž b, b. wth respect to b. From j E 1 b q R Ž b,bj. s Ž cyb yb. y s0 Ž 5.7 j. Eb c c

11 and M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) E y 1 q R b,b s y -0, Ž 5.8 Ž j.. Eb c c one obtans Ž qc. b scyb Ž 5.9. j for, js1, and /j. Lettng b q sb sb, we get 1 b q sb q c scr 3qc Thus, wth c)0, each prncpal P, who s restrcted to contracts of the form q 5.1, wll choose a postve ncentve parameter b. Insertng bqsbsbj nto Eq. Ž 5.4. reveals that the market outcome s the same as n Secton. 1 q x s Ž qc 1qc q p s Ž qc c 1q q q q R Ž x, x j. s yc. Ž Ž 3qc. It may or may not surprse the reader that strategc delegaton under Ž 5.1. leads to the same outcome as the usual Cournot model. 6 To see why, note that each prncpal can nfluence only hs own agent s choce of sales Žsee Ž Therefore, n equlbrum each prncpal chooses sales ncentves so as to nduce hs agent to choose the sales amount whch s a best reply to the sales amount of hs compettor. 7 nlke n Secton 4, where each prncpal nfluenced both agents choces of sales Žsee Ž 3.4.., there s no commtment value to dong dfferently. Ths does not mean, however, that strategc delegaton does not matter. Suppose that only prncpal P could use strategc delegaton accordng to Ž 5.1., whle the other producer was left on hs own Ž lke the frms n Secton.. Frst, P announces a contract, then hs agent and the other producer smultaneously choose sales amounts. In ths case one can show that n equlbrum P enjoys the same advantage as would a Stackelberg leader. 6 In ths respect, our results here dffer from many classcal results on strategc delegaton Ž Fershtman and Judd, 1987 and others.. Agan ths s because dfferent sets of possble strategc delegaton contracts are used. 7 It may seem odd that prncpals s1, do not order ther agents drectly to sell x q. A reason could be that prncpals do not observe sales amounts Žf customers pay b per unt to the agent, the prncpal would deduce from hs proft R the sales x only when x would be known. j. Many prncpal-agent models Ž see for example Holmstrom, assume that producton s stochastc and that only agents learn about actual output levels.

12 9 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) Prvately known types Our analyss has so far assumed that the relevant type parameters Ž b, b. j are commonly known when sales decsons are made. A very dfferent nformatonal assumpton would be that these parameters are prvate nformaton Žeach knows only hs own b n the ndrect evolutonary approach, each prncpal P and agent A knows only the contract he has sgned n the strategc delegaton case.. In the followng, we brefly comment on how our results are affected n ths case. In the ndrect evolutonary approach, suppose that the seller s belefs concernng the other frm s b g M are determned by the true dstrbuton n the populaton. Ths s a standard case wth prvate nformaton Ž see e.g., Guth, Then, Ž see Guth and Peleg, 1997 for a general analyss. only b s 0 can be evolutonarly stable. The reason s that f a partcular seller s type would change only would react. It follows that only a best reply n terms of market success e., wth no ndependent weght for sales. can be evolutonarly stable. b s 0s best aganst b s0 and thus evolutonarly stable. 8 For strategc delegaton a smlar extenson of our analyss to prvately known types yelds the same results. If a prncpal cannot publcly announce the ncentves of hs agent, ncentves guaranteeng best reples n terms of market success are clearly best. Thus, also n ths case the standard Cournot outcome results Concluson To explan nsttutons, one can refer to a pre-nsttutonal decson stage where players decde strategcally about the future nsttutonal set up. An example of ths knd of strategc delegaton s the well-known, nevertheless fcttous, contrat socal, but also the stage of mechansm choce n the theory of mechansm desgn whch assumes that certan ndvduals can decde about the mechansms to be appled later. An alternatve approach s that of Ž ndrect. evoluton. In the sprt of purposve or spontaneous socal formatons of Hayek Ž 195. Ž Chapter 1.VIII., no 8 Here, of course, we mplctly rely on the usual assumpton Ž n evolutonary game theory. that sellers nteract only once n the market. If before reproducng the same sellers would repeatedly sell on the market, former sales choces mght sgnal one s own b-ncentve. That s, prvate nformaton could be revealed. Concevably t may then be mportant to have other ncentves than b s0. Just as n the case where ncentves are commonly known, the other frm s behavor may change. 9 Compare Guth and Klemt Ž who Ž n a dfferent economc context. apply an ndrect evolutonary approach and dscuss also nformatonal assumptons whch are ntermedate to the polar cases where types are common knowledge and prvate nformaton, respectvely.

13 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) one ntentonally desgns the future set up. 10 The precse structure s rather determned by the relatve success of the alternatve desgns n the gven nsttutonal envronment. Ths reveals an essental dfference of the two approaches. Whereas the frst approach needs an all encompassng game model the second one does not requre ths, as the strategc choce of future rules s replaced by modelng the evoluton of such rules. In the specfc context of a smple duopoly market, where sellers mght care about sales n addton to proft, we have scrutnzed the argument that these conceptually very dfferent approaches yeld the same outcome. A preconcepton why ths may happen can be based on the observaton that both approaches allow for certan knds of commtment regardng future behavor. In the case of strategc delegaton such commtments take the form of chosen ncentve contracts, under ndrect evoluton they correspond to preferences whch have evolved over tme. The results leadng up to Theorem show that wth a tght correspondence between the mutant space of the ndrect evolutonary approach and the set of feasble contracts n the strategc delegaton approach, ndeed the two approaches lead to the same outcome. Ths results llustrates a techncal smlarty between the two approaches, and that the ndrect evolutonary approach may be thought of n terms of a partcular form of strategc delegaton. However, f one starts out n a framework of strategc delegaton wth nducement of sales concerns, also other sets of feasble contracts may appear natural. Wth such contracts, the results concernng strategc delegaton may change. Ths underscores the conceptual dfferences between ndrect evoluton and strategc delegaton. If a partcular mutant space s natural n an evolutonary settng, whle a dfferently motvated set of contracts s natural under strategc delegaton, then the economc outcome may be senstve to whether the market nsttuton s shaped by evoluton or by desgn. In closng, we note that the ndrect evolutonary approach has a shorter hstory n economc research than does strategc delegaton. In our vew the ndrect evolutonary analyss deserves more attenton, as t offers a new and nnovatve perspectve to explanng economc nsttutons. Lke strategc delegaton, the approach does not deny that decson makers are ratonal. nlke strategc delegaton t does not requre an all encompassng game model whch has to specfy for example the ncentves, the nformaton condtons, and the strategc possbltes of those who decde about the future nsttutonal set up. One does not 10 We are grateful to the edtor Arye Hllman for suggestng that we refer to Hayek, who we beleve would be ntrgued by the ndrect evolutonary approach. Hayek Ž 195. wrtes: Many of the greatest thngs man has acheved are not the result of of conscously drected thought Ž p He credts Adam Smth and Carl Menger wth smlar deas and approvngly ctes Menger: how t s possble that nsttutons... can arse wthout a common wll amng at ther creaton s... perhaps the most sgnfcant problem of the socal scences Ž p. 83..

14 94 M. Dufwenberg, W. GuthrEuropean Journal of Poltcal Economy 15 ( 1999) have to model a pre-nsttutonal decson stage, but rather the evoluton of economc nsttutons. The fact that strategc delegaton and ndrect evoluton are conceptually dfferent suggests, however, that these are n no way competng approaches. Rather the two shed ndependent lght on how economc nsttutons can be explaned. In prncple, the two approaches can even be employed together, for example by assumng a market wth strategc delegaton and by dervng the evolutonarly stable rules of strategc delegaton Žprncpal and agent may, for nstance, develop a feelng of corporate dentty whch could be captured by mutual altrusm as by Bester and Guth, Acknowledgements The paper was wrtten whle Werner Guth was vstng CentER. We thank Edward Droste, Manfred Kongsten, and two anonymous referees for very helpful comments. Martn Dufwenberg thanks the European non s HCM-Network project Games and Markets organzed by Helmut Bester for fnancal support, Werner Guth thanks CentER for hosptalty. References Bak, K.H., Km, I.-G., Delegaton n contests. European Journal of Poltcal Economy 13 Ž., Bester, H., Guth, W., Is altrusm evolutonarly stable?. Journal of Economc Behavor and Organzaton 34 Ž., Boyd, R., Rcherson, P.J., Culture and the Evolutonary Process. nversty of Chcago Press, Chcago. Callaud, B., Jullen, B., Pcard, P., Competng vertcal structures: precommtment and renegotaton. Econometrca 63, Cournot, A., In: Bacon, N. Ž Ed.., Recherches sur les prncpes mathematques de la theore des rchesses. wenglsh edn. Researches nto the Mathematcal Prncples of the Theory of Wealth. x Macmllan, London, Fershtman, C., Judd, K., Equlbrum ncentves n olgopoly. Amercan Economc Revew 77, Fershtman, C., Gneezy,., Strategc delegaton: an experment. Workng Paper a The Foerder Insttute for Economc Research, Tel Avv nversty. Fershtman, C., Kala, E., n press. nobserved delegaton. Internatonal Economc Revew. Fershtman, C., Judd, K., Kala, E., Cooperaton through delegaton. Internatonal Economc Revew 3, Gal-Or, E Multprncpal agency relatonshps as mpled by product market competton. Mmeo, nversty of Pttsburgh. Green, J., Strategc use of contracts wth thrd partes. Dscusson Paper a150, Harvard nversty. Guth, W., An evolutonary approach to explanng cooperatve behavor by recprocal ncentves. Internatonal Journal of Game Theory 4,

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