The Effect of Options on Coordination

Abstract

This paper studies how constraints on the timing of actions affect equilibrium in intertemporal coordination problems. We show that while the possibility of waiting longer for others'’ actions helps agents to coordinate in the good equilibrium, the option of delaying one’s' actions harms coordination and can induce severe coordination failures: if agents are very patient, they might get arbitrarily low expected payoffs even in cases where coordination would yield arbitrarily large returns. The risk-dominant equilibrium of the corresponding one-shot game is selected when the option to delay effort is commensurate with the option to wait longer for others’' actions. In an application to innovation processes, we show that protection of the domestic industry might hinder industrialization. We also argue that increased competition might have spurred the emergence of shadow banking in the last few decades.

Keywords: coordination failures, delay, option, strategic complementarities

JEL Classification: C72, C73, D84