Joel Watson

Conditional Dominance, Rationalizability, and Game Forms

We propose a notion of conditional dominance for games whose representations designate information sets. We prove that iterated conditional dominance is equivalent to extensive form rationalizability. We also conduct a general analysis of these concepts, yielding new insights on rationalizability and on the equivalence of solutions when applied to different representations of a game.

Recurrent Trade Agreements and the Value of External Enforcement

This paper presents a theory of dynamic trade agreements in which external institutions, such as the WTO, play a central role in supporting credible enforcement. In our model, countries engage in ongoing negotiations, and as a consequence cooperative agreements become unsustainable in the absence of external enforcement institutions. By using mechanisms such as delays in dispute resolution and direct penalties, enforcement institutions can restore incentives for cooperation, despite the lack of any coercive power. The occurrence of costly trade disputes, and the feasibility of mechanisms such as escape clauses, depend on the adaptability of enforcement institutions in their use of information.

Hard evidence and mechanism design

This paper addresses how hard evidence can be incorporated into mechanism-design analysis. Two classes of models are compared: (a) ones in which evidentiary decisions are accounted for explicitly, and (b) ones in which the players make abstract declarations of their types. Conditions are provided under which versions of these models are equivalent. The paper also addresses whether dynamic mechanisms are required for Nash implementation in settings with hard evidence. The paper shows that static mechanisms suffice in the setting of evidentiary normality and that, in a more general environment, one can restrict attention to a class of three-stage dynamic mechanisms.

Learning about a population of agents and the evolution of trust and cooperation

Abstract Various reputation models consider how cooperation might emerge between rational adversaries in non-cooperative games. We suggest and analyze an additional determinant: uncertainty and learning about the population from which agents are selected. The analysis shows how the degrees of trust by principals and cooperation by agents can depend on the past behavior of other agents. A dramatic implication is that trust and cooperation can permanently and inefficiently break down due to revised beliefs about the population of agents. We consider lessons the theory might provide concerning the relationship between the U.S. Department of Defense and its contractors. The model suggests two explanations of events during the mid-1980s, which many interpret as a very socially costly breakdown of trust and cooperation.

Job Destruction and the Experiences of Displaced Workers

This paper evaluates a class of endogenous job destruction models based on how well they explain the observed experiences of displaced workers. We show that pure reallocation models in which relationship-specific productivity drifts downward over time are difficult to reconcile with the evidence on postdisplacement wages and displacement rates. Pure reallocation models with upward drift can explain the evidence, but implausibly large and persistent negative productivity shocks are required to generate displacements. Combining upward drift with outside benefits or moral hazard as additional motives for displacement makes it possible to explain the evidence with much smaller shocks. Propagation of aggregate shocks, welfare implications of displacement, upgrade of relationships in lieu of displacement, and learning effects are also discussed.

The Law and Economics of Costly Contracting

In most of the contract theory literature, contracting costs are assumed either to be high enough to preclude certain forms of contracting, or low enough to permit any contract to be written. Similarly, researchers usually treat renegotiation as either costless or prohibitively costly. This paper addresses the middle ground between these extremes, in which the costs of contracting and renegotiation can take intermediate values and the contracting parties can themselves influence these costs. The context for our analysis is the canonical problem of inducing efficient relation-specific investment and efficient ex post trade. Among our principle results are: (i) The efficiency and complexity of the initial contract are decreasing in the cost to create a contract. Hence, the best mechanism design contracts can be too costly to write. (ii) When parties use the simpler contract forms, they require renegotiation to capture ex post surplus and to create efficient investment incentives. In some cases, parties want low renegotiation costs. More interesting is that, in other cases, parties have a strict preference for moderate renegotiation costs. (iii) The effect of Contract Law on contract form is significant but has been overlooked. In particular, the laws interpretive rules raise the cost of enforcing complex contracts, and thus induce parties to use simple contracts. Worse, the law also lowers renegotiation costs, which further undermines complex contracts and is also inappropriate for some of the simpler contracts.

Conceptualizing Contractual Interpretation

Many litigated written contracts require interpretation, but few formal treatments of the interpretive process exist. This paper analyzes welfare-maximizing interpretive rules. It shows that (1) accurate interpretations maximize expected gains by rewarding parties only for compliant performances; (2) an optimal interpretive rule trades off these gains against the costs of writing contracts, investing in the deal, and trials; (3) an efficient interpretive process sometimes requires an adjudicator to decide on the basis of the writing and the tendered performance, without a trial; (4) courts maximize accuracy in interpretation rather than welfare, which yields too many trials, prevents some efficient contracting relationships from forming, and distorts contract writing; (5) party preferences regarding interpretation often are closer to first best than judicial preferences, so legal interpretive rules should be defaults; and (6) arbitration is more attractive to parties when the interpretive task requires inferring intent from a tendered performance rather than from a writing.

Communication and superior cooperation in two-player normal form games

Abstract In many games, players may be able to cooperate for their collective benefit without jeopardizing individual rationality However, attaining such superior cooperation requires that players conform to a specific axiom of behavior. In this paper, I demonstrate that pre-play communication also stimulates superior cooperation.

Testing and the Composition of the Labor Pool

We consider a continuous-time labor matching model with endogenous separation. Firms initially lack information about the quality of workers with whom they are matched. They acquire information both from pre-employment testing and, in the case in which a labor relationship is established, on-the-job performance. Testing provides a signal of a workers quality. A firm can pick the accuracy level of its test, but it pays a cost that increases in the accuracy. Workers who perform poorly on the test are not offered employment; those who perform poorly on the job are eventually fired (after some delay). Worker quality is not match-specific; low-quality workers are less productive with all firms. We show that, in equilibrium, there is an inverse and complementary relation between the level of testing that firms optimally perform and the overall quality of the workers in the matching pool. We consider the properties of a steady-state, stable equilibrium in such an environment. The complementarity between testing and the composition of the unemployed pool introduces the possibility of multiple equilibria.