“Credible Commitments: Ex Ante Deterrence and Ex Post Compensation” by Cheng-Zhong QIN
And Department of Economics and Finance City University of Hong Kong
The primary objective of this paper is to characterize for a given commitment device, credible commitments that induce players to play a pre-specified strategy profile in a 2-person game. Commitments are soft in the sense that they can be revoked at a cost. Two commitment devices are particularly studied. Under the first one, each player can commit himself to compensate the other player for damages caused by his deviation from his pre-specified strategy. The second one involves the compensation mechanism of Varian (1994), which allows each player to commit himself to compensate the other player for playing his pre-specified strategy. Explicit characterizations of credible commitments inducing mutual cooperation in prisoner's dilemma, symmetric or asymmetric, are established for these two commitment devices. These characterization results provide a prospective assessment for the selection of liquidated remedies. In particular, it is shown that when viewed ex ante, large liquidated remedies are not incentive compatible. Hence they should not be put into contracts by rational parties.