Working Paper: CEPR ID: DP2600
Authors: Mike Burkart; Klaus Wallner
Abstract: We develop an incomplete contract model to analyse the enlargement strategy of a club. An applicant is characterized by his wealth and the degree of conformity with the club standard. The club gains only from a fully reformed new member, but reform is costly. The club chooses between early admittance, where it can enforce reform through its partial control power, and late admittance, where entry is conditional on completed reform. Under the optimal enlargement strategy of the club, wealthy applicants pay an entrance fee and enter early, and poor applicants enter in reversed order: A less advanced member is admitted early, and a more advanced one, late. Moreover, poor applicants extract rents that increase in the ratio of reform distance to wealth. If the club can impose a deadline for late entry, it can eliminate all rents with stage financing. In the dynamic game, renegotiation undermines the viability of the late admittance strategy. In the finite game, the applicant's rent from a late offer is non-monotonic in his reform distance and the ability to deteriorate his reform status strategically need not be detrimental to the club.
Keywords: club theory; governance; incomplete contracts; reform incentives
JEL Codes: D71; G30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Timing of an applicant's entry into a club (C41) | Incentives to reform (O31) |
| Wealth of applicants (I24) | Timing of entry into the club (C41) |
| Timing of entry into the club (C41) | Distribution of benefits among members (D30) |
| Wealth of applicants (I24) | Likelihood of early entry (C41) |
| Reform status of applicants (I28) | Timing of entry into the club (C41) |
| Club's control over resources (Z23) | Optimal admission strategy (C61) |
| Reversed order of admission (Y40) | Maximizing club's utility (D71) |
| Deadline for entry (Y20) | Elimination of rents for late applicants (R21) |