Long-term partnership for achieving efficient capacity allocation

We consider a capacity provider and a group of independent buyers who partner to share a scarce but expensive-to-build capacity over a finite horizon under privately informed demand conditions. At the beginning of the time horizon, the capacity provider must invest in building capacity; all members may invest in increasing their own and possibly other members'market sizes. Then eachmemberobserves andupdates itsprivate, history-dependent demand information over time. Because the value of the capacity to each member is highly uncertainwhen investment ismade, achieving the first-best outcome while sustaining under a dynamic environment is challenging for the partnership.We address this issue by proposing a multiperiod membership-type agreement (referred to as the Agreement) as a series of singleperiod contractswith flexible terms that are renegotiated each period. TheAgreement enforces ex post efficient capacity allocation and ex ante efficient investment. The set of interpartner transfers in the Agreement makes each member a residual claimant to the surplus it creates, and hence induces truthful demand reports. This contract is also budget balanced and voluntary. In doing so, we develop a new solution concept for dynamic collective action mechanisms.

Duke Scholars

Author Jing-Sheng Song Fuqua School of Business