Incentive Design on Networks

We consider a productive network formed by agents with heterogeneous privately-known productivity types. Under convex cost of link formation, bilateral links create endogenous externalities. We calculate the "rearrangement cost" imposed on the entire network by each subset of other agents an agent can link to, and the consequent social opportunity cost of such subsets. We construct a mechanism to implement the socially optimal network, which specifies transfers based on the calculated opportunity cost, and a allocation to each agent consisting of network links. Once agents form allocated links, network connections might reveal further information to an agent on types of other agents. As a robustness check we allow pairwise adjustments under full information at the stage after forming the allocated network. We show that the mechanism is strict ex post incentive compatible, implements the optimal network as a pairwise-stable network and does not have a budget deficit