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Verifiability and Group Formation in Markets

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Verifiability and Group Formation in Markets∗ Suzanne Scotchmer Department of Economics and Boalt School of Law, UC Berkeley and NBER Chris Shannon Department of Economics, UC Berkeley this version: October 11, 2010 Abstract We consider group formation with asymmetric information. Agents have unverifiable characteristics as well as the verifiable qualifications required for memberships in groups. The characteristics can be chosen, such as strategies in games, or can be learned, such as skills required for jobs. They can also be innate, such as intelligence. We assume that the unverifiable characteristics are observable ex post (after groups have formed) in the sense that they may affect the output and utility of other agents in the group. They are not verifiable ex ante, which means that prices for memberships cannot depend on them, and they cannot be used for screening members. The setup includes problems as diverse as moral hazard in teams, screening on ability, and mechanism design. Our analysis, including the definition of equilibrium and existence, revolves around the randomness in matching. We characterize the limits on efficiency in such a general equilibrium, and show that a sufficiently rich set of group types can ensure the existence of an efficient equilibrium. Keywords: clubs, games, contracts, lotteries, general equilibrium JEL Codes: C02, C62, D2, D62, D83 ∗We thank Birgit Grodal and Salvador Barbera for important conversations in the early stages of this project, and seminar participants at the Toulouse School of Economics, especially Patrick Rey, and Collegio Carlo Alberto for helpful comments. We gratefully acknowledge the support of the NSF under grants SES- 0531184, SES-0721145, and SBE 0830186. Shannon thanks the Center for Advanced Study in the Behavioral Sciences at Stanford University. Email: [email protected], [email protected] 1 1 Introduction What determines the contracts, mechanisms, games, and other organizational forms tha

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