Strategic delegation under fulfilled expectations

Abstract Fershtman and Judd (1987) show that profit-oriented owners delegate pricing decisions to managers through contracts that incentivize them to behave less aggressively. Hoernig (2012) extends their analysis to environments with network effects and finds that, when network effects are strong enough, the result is reversed and that optimal delegation contracts incentivize managers to behave more aggressively. This paper revisits Hoernig (2012) by assuming that consumers form expectations about network sizes before owners choose delegation contracts, in contrast with Hoernig’s (2012) assumption that expectations are formed after the contracts are chosen. That is, the current study employs fulfilled (or passive) expectations, while Hoernig (2012) uses rational (or responsive) expectations. We show that under the fulfilled expectations, Fershtman and Judd’s (1987) results hold, regardless of the strength of the network effect.