Strategic Delegation By Unobservable Incentive Contracts

Many strategic interactions in the real world take place among delegates empowered to act on behalf of others. Although there may be a multitude of reasons why delegation arises in reality, one intriguing possibility is that it yields a strategic advantage to the delegating party. In the case where only one party has the option to delegate, we analyse the possibility that strategic delegation arises as an equilibrium outcome under completely unobservable incentive contracts within the class of two-person extensive form games. We show that delegation "may" arise solely due to strategic reasons in quite general economic environments even under unobservable contracts. Furthermore, under some reasonable restrictions on out-of-equilibrium beliefs and actions of the outside party, strategic delegation is shown to be the "only" equilibrium outcome. Copyright The Review of Economic Studies Limited, 2004.