Endogenous Group Formation and Monitoring

AuthorHu Zhang; Weiying Zhang
Pages384-387

Hu Zhang. The Central University of Finance and Economics, China

Weiying Zhang. Peking University, China (jameshall@163.com)

Page 384

Introduction

In the real world, there exist various economic, ethnic and tribal divisions. For example, ancient Greece once was a collection of poleis. Ancient Rome divided its territory into different provinces. And Chinese political division has experienced the transition from system of Enfeoffment to Province. One may wonder what determinants work behind so many different grouping structures. Unfortunately, we cannot directly find the answer from the existing economic theories. Only a few papers have mentioned this issue. Dixit (2002), for example, once pointed out that the consideration of endogenous structure may be an extension to his model. But he didn’t give the specific analysis and further explanation. Obviously, grouping structure is an important but neglected topic.

This paper is an attempt to explore the diversification of grouping structures by an infinitely repeated matching game. In our opinion, the optimal group division structure should minimize the distortion induced by the informational imperfection. Here we assume that the members within a group own inside information, who can disclose the miscreant actions she observed to show her innocence. Besides, there is also public information which can be observed by a trustworthy intermediary. These two types of information constitute the information transmission mechanism. The specific grouping structures will determine the efficiency of peer monitoring and public signal transmission. Since the rule of information transmission mechanism varies across different situation, it requires different optimal grouping structures.

This paper is organized as follows. In Section 2, we review the relating literatures. In Section 3, we build a model by assuming that the payoff might vary each period. Under this condition, we find that the information transmission mechanism does affect the formation of grouping structure. In Section 4 we conclude.

Literature Review

Now let’s explain how our work is connected with existing models to the notion of stereotype. The first one is matching game theory which has rapidly developed since the pioneering work of Rosenthal (1979). Kandori (1992) once built a two-group matching game, in which each player can only be matched with another one from the opposite group. Ellison (1994)Page 385 loosed this constraint and extended the model to a randomly matching game, which convention is followed by our model. The literature referring to grouping problem includes Genicot and Ray (2003) analyzed...

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