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How coalitions get built: Evidence from an extensive form coalition game with renegotiation & externalities Gary E. Bolton Penn State University, USA Jeannette Brosig University of Cologne, Germany

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Observation: Many coalitions are formed sequentially. international trade treaties (e.g., formation of NAFTA) environmental agreements (e.g., formation of CITES) mergers and acquisitions (e.g., Glaxo mergers) There are often positive or negative externalities involved. Our study investigates the process of coalition formation in a finite horizon non-cooperative bargaining game. MOTIVATION

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Proposed-to members: Accept or reject proposal Player A: Proposes coalition / a split of the coalitions’ earnings Stage 1: All accept. No coalition 3-PLAYER COALITION GAME At least one rejects. Coalition No coalition

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Proposed-to members: Accept or reject proposal Player A: Proposes (to enlarge) coalition / a split of coalitions’ earnings All accept. No (enlargement of) coalition 3-PLAYER COALITION GAME At least one rejects. (Enlargement of) coalition No coalitionTwo-player coalition Stage 2:

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Coalition values Treat. V(AB)V(AC)V(B)V(B)V(C)V(C) T24638117 PREDICTION No coalition: v(A) = v(B) = v(C) = 14 Grand coalition: V(ABC) = 66 SPE coalitions 1 st stage 2 nd stage SPE final payoffs (A, B, C) [AB] [ABC] (42,16,8) (all payoffs in U.S. dollar)

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Coalition values Treat. V(AB)V(AC)V(B)V(B)V(C)V(C) T146382117 T24638117 T3 PREDICTION No coalition: v(A) = v(B) = v(C) = 14 Grand coalition: V(ABC) = 66 SPE coalitions 1 st stage 2 nd stage SPE final payoffs (A, B, C) [ABC](36,15,15) [AB] [ABC] (42,16,8)

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Coalition values Treat. V(AB)V(AC)V(B)V(B)V(C)V(C) T146382117 T24638117 T35638117 PREDICTION No coalition: v(A) = v(B) = v(C) = 14 Grand coalition: V(ABC) = 66 SPE coalitions 1 st stage 2 nd stage SPE final payoffs (A, B, C) [ABC](36,15,15) [AB] [ABC] (42,16,8) [AC] [ABC] (46,12,8)

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Final coalitions: - grand coalitions formation in about 46 percent of all cases - bias towards the inefficient coalition [AB] - greater tendency towards this bias in treatment T3 Final payoffs: - ordinal payoff differences between players largely in line with prediction - compression of payoffs towards equality Process of coalition building: RESULTS Outcome: most coalitions form in one step even where theory predicts two V(AB)V(AC)V(B)V(B)V(C)V(C)SPEfinal payoffs T146382117[ABC](36, 15, 15) T24638117 [AB] [ABC] (42, 16, 8) T35638117 [AC] [ABC] (46, 12, 8)

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Explanation??? (1)Investigating the two stages of coalition formation in more detail indicates that observed behavior is guided by relative payoffs. (2)Standard analyses of the role of relative payoffs in bargaining (Bolton and Ockenfels 2000, Amer. Econ. Rev.) fall short of the data... (3)Relative payoff considerations are rather myopic. failure to backward induct (see Johnson, Camerer, Sen, and Rymon 2002, J. Econ. Theory) complex bargaining situation (greater strategic uncertainty) RESULTS

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Building an efficient grand coalition seems to be challenging. How does communication affect behavior? Communication leads to a higher rate of efficient coalitions. Communication is a crucial factor in successful coalition building. CONCLUSION

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