Knowledge that Transforms

The double auction trading institution (DA) has been highly efficient across diverse marginal-cost market structures, whether human subjects or "zero-intelligence" robots populated those markets. Accordingly, many researchers suspect that DA performance transcends market structure and agent strategy. But we show that (1) large avoidable costs undermine the efficiency and stability of human subject DAs, and (2) these low human efficiencies are simultaneously well above zero-intelligence efficiencies. Our results dramatically illustrate the potential havoc wrought by highly competitive institutions when they must cope with nonconvex technologies.

A two-stage game is used to model firms' strategic incentives to divide production among autonomous competing units through divisionalization, franchising, or divestiture. Firms simultaneously choose their number of competing units, which then engage in Cournot competition. While it is costly to form autonomous units, each firm does so in equilibrium, thus reducing firm profits and increasing social welfare relative to the case where firms cannot form competing units. With linear demand and costs, duopolists choose the socially optimal number of competing units; oligopolies with larger numbers of firms choose too many. The case of nonlinear demand is also examined.