DP2600 Club Enlargement: Early Versus Late Admittance

Author(s): Mike Burkart, Klaus Wallner
Publication Date: November 2000
Keyword(s): Club Theory, Governance, Incomplete Contracts, Reform Incentives
JEL(s): D71, G30
Programme Areas: Financial Economics, Transition Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2600

We develop an incomplete contract model to analyse the enlargement strategy of a club. An applicant is characterized by his wealth and the degree of conformity with the club standard. The club gains only from a fully reformed new member, but reform is costly. The club chooses between early admittance, where it can enforce reform through its partial control power, and late admittance, where entry is conditional on completed reform. Under the optimal enlargement strategy of the club, wealthy applicants pay an entrance fee and enter early, and poor applicants enter in reversed order: A less advanced member is admitted early, and a more advanced one, late. Moreover, poor applicants extract rents that increase in the ratio of reform distance to wealth. If the club can impose a deadline for late entry, it can eliminate all rents with stage financing. In the dynamic game, renegotiation undermines the viability of the late admittance strategy. In the finite game, the applicant's rent from a late offer is non-monotonic in his reform distance and the ability to deteriorate his reform status strategically need not be detrimental to the club.