BPP Field Exam 2006 Answers

Answer A.1: The Theory of Partnerships

A.1: The Theory of Partnerships

A partnership group has a surplus it needs to allocate to the partners at the end of the year. The procedure it uses (as enshrined in its Operating Agreement) is as follows. Decisions are made by a committee-of-the whole (i.e. the entire partnership). At the annual meeting for the partnership, one of the partners is chosen randomly (with each having an equal likelihood of being selected) to propose an allocation to each of the members, including herself. If her proposal is accepted by a majority of the partnership, then that proposal is implemented. If it is not passed by a majority, then another partner is chosen randomly to make a proposal and the procedure repeats. All of the partners prefer higher allocations to lower allocations, and faster decisions to slower decisions.

a.) Outline a model of the above situation. Assuming the game is a single-shot and there are no punishments by the partnership (no reputation effects), discuss the equilibrium for your model. Note: you do not have to solve the model; simply discuss the proposition(s) you expect that could be derived and the intuition(s) behind it (them).

Application of Baron & Ferejohn (1989) - Close Rule, Finite Session (e.g. n=2) Backwards induction yields a SPNE in which each member, if recognized, makes the same majoritarian proposal to distribute the benefits to a minimal winning majority (characterized in Proposition 1).

b.) Suppose that the partnership (membership) is stable, infinitely-lived, and makes a surplus allocation decision every year. How would you account for this in your model? Discuss equilibrium behavior and strategies using these assumptions (again you do not need to explicitly solve the model, simply explain your reasoning).

Application of Baron & Ferejohn (1989) - Closed Rule, Infinite Session

c.) Returning to the one-shot/no-reputation case, consider what would happen if partnership shares are not distributed evenly, and members have probabilities of being recognized which are proportional to their shares. What would be the equilibrium strategies and outcomes you would expect in this case?

d.) Finally, consider what would happen if both voting rights and recognition probabilities were proportional to the shares held, what would you expect in this case?