Contracting against Non-contractible Outsider

Abstract: This paper studies contracting in the presence of externalities with a non-contractible outsider. Multiple equilibria arise from strategic symmetry between the insider agent and the outsider. To address strategic uncertainty, the principal guarantees their actions in a unique equilibrium. A novel duality approach reformulates her problem as a series of problems in which she selects agent expectations. The key constraint is that the principal cannot convince the agent to expect non-guaranteed response from the outsider. Due to strategic rents, the principal optimally induces attenuated agent incentives. With completely symmetric strategic dependence, her coordination and commitment power become perfect substitutes; in addition, public contracting can strictly decrease her surplus compared to private contracting, in sharp contrast with the case where she ignores robustness. Applications include regulating international competition, platform design, and labor union contracting.