Tough Bargains: When Cooperation is More Competitive than Competition

Abstract

Economic agents frequently take long-term actions, regarding for instance investments in cost reduction or R&D, before engaging in more short-term interactions, e.g. through price setting. Those short-term interactions may be noncooperative as for example competition on a consumer market, or cooperative and based on negotiations. This raises the question of how long-term actions that prepare for subsequent cooperation differ from those that precede noncooperative interaction. Can it happen that agents prepare more aggressively for cooperation than for competition, and thus destroy some of the value they create through cooperation by preparing for it? If so, under what conditions? To address these questions, I analyze two-stage duopoly games in which agents move noncooperatively in Stage 1, followed by either noncooperative or cooperative moves in Stage 2. In the latter case, a biform game, agents bargain in Stage 2 over how to divide the joint payoff. I show that Stage-1 actions can be more competitive in preparation for cooperation than in preparation for noncooperative interaction, in the sense of deviating more from the benchmark of collusion in both stages, and derive conditions for this to be the case. For instance, in preparation for a merger competing firms invest more in cost reduction than when preparing for price competition. Such increased investments can be wasteful for the duopolists and for society. My results also suggest that economic actors should pay attention to the pre-negotiation phase when arranging cooperation talks.