Credible Commitments

1
Credible Commitments

• Reading Chapter 6

2
The eightfold path to credibility

• Breaking commitment is costly
• Establish and use of a reputation
• Write contracts
• Arbitrary ending of negotiations
• Cut off communication
• Burn bridges behind you
• Leave the outcome to chance
• Separating commitments in small compromises
• Move in small steps
• Delegation
• Teamwork
• Managers

3
Breaking commitment is costly

• Establish and use of a reputation
• Important difference between complete information
  and incomplete information
• In the first case you can not pretend while in
  the second case you can pretend.
• The reputation in the first case must come from
  actual benefits and actual costs that are known.
• The reputation in the second case is like
  pretending to be somebody it is better called
  disguised.
• Building reputation requires repeated
  interactions.
• What you do should be somehow observable. Ex
  teamwork in a company might not increase your
  reputation if there is no monitoring (The Rat).

4
Breaking commitment is costly

• Establish and use of a reputation
• Establishing a reputation is costly. Trade-off
  todays cost for future gains.
• Ex Israels hostage policy Saving lifes today
  vs. reducing the number of attacks in the future
• Ex Return policy no questions ask some returns
  are unfair (one time use for special events or
  dislikes after some use) but that makes buying
  easier and people buy more.
• Crazy reputation strategy everything is
  possible. Is that credible.
• Incomplete information you can pretend
• Complete information it must be credible
  (benefits higher than costs).
• Ex Is the North Korean leader crazy (saying that
  testing nuclear weapons) or is rational. We know
  that he is cruel and corrupt butrisk of
  punishment really low (US in Irak and
  Afghanistan) and benefit really high (joining the
  nuclear club). If US pulls out of Irak he will
  stop that testing

5
Breaking commitment is costly II

• Write contracts
• The law enforces your commitments.
• Problem of renegotiation.
• Sometimes the punishment is much higher and it is
  better to pay a little less and get back to the
  contract.
• Not all contracts are enforceable.
• Enforceability is not the written one but the one
  that is real after including renegotiation. Ex
  companies going down.
• Ex Lowest price guarranteed
• Idea dont bargain with me
• If it is believable nobody will check other
  prices. Then it is optimal to break that
  commitment (although it is contracted already).
  So nobody should believe that they are actually
  offering the lowest prices.

6
Arbitrary ending of negotiations

• Cut off communication
• Irreversible moves
• Example deadline is at 9 AM on Monday I will
  close the door and leave my office.
• Problem reinforcement and renegotiation.
• Solution make somebody else be in charge of
  renegotiation.
• Burn bridges behind you
• Ex in book (Polaroid and Kodak) is more related
  to reputation
• Benefits of reputation for Polaroid (I will only
  produce and defend in the instant film market)
  went down (other alternatives).
• Opportunity cost for keep9ing a reputation went
  up the other markets were growing a lot.
• Example.
• Leave the outcome beyond your control
• Brinkmanship Second part.

7
Separating commitments in small compromises

• Move in small steps
• Creates a reputation game
• Reduces the breakdown costs (the future is not
  coming) or increases the reputation value (the
  future is bright).

8
Delegation

• Teamwork
• AA two possible explanations
• Change your behavior because you are there and
  you feel differentNO!!!!
• Punishment if you fail (peer humiliation) and
  reduced cost for keeping your word (sponsor).
• Story dude.
• Managers