Assurance Contracts

by on May 13, 2005 at 7:10 am in Economics | Permalink

Many public goods and club goods exhibit increasing returns.  A lighthouse, for example, is useless unless complete.  It’s difficult to get voluntary contributions to these types of good not only because of the free rider problem but also because contributors fear that their contribution will be wasted if others do not also contribute.  An assurance contract makes contributions contingent on some level of total contribution being reached.

Assurance contracts can help to solve coordination problems.  I agree to contribute to build the lighthouse if and only if enough others also agree so that production is guaranteed.

Fundable.org is making assurance contracts easier to implement.  If you want to raise money for a cause you can set up a Fundable group.  Contributions to the group goal are held by Fundable in escrow.  All money is returned unless the group goal is met.  If the group goal is met the funds are paid to the group leader.

It’s a cool idea but even more is possible.  In a paper published a few years ago, I show that the idea of assurance contracts can be extended to what I call dominant assurance contracts.  In a dominant assurance contract if the group goal is not met then everyone who offered to contribute is given their money back plus a bonus.  It turns out that it then becomes a dominant strategy to contribute and the public good is always provided!

Comments on this entry are closed.

Previous post:

Next post: