Information Asymmetry Models in the Internet Connectivity Market

This paper discusses the structure of the Internet connectivity market by focusing on the business relations of stakeholders involved in network services provision. We believe that the role of information asymmetry is critical when considering interconnection agreements, and should be taken into account in the structure of the contract. Information asymmetry due to incomplete information concerning important operating parameters such as network load, capacity, cost, gives rise to adverse selection during negotiation and contract preparation. The current at structure of interconnection agreements does not address such information asymmetries. In many cases, the dfficulty of observing the actual effort allocated by the contracted network for providing quality of service, and in particular, the absence of appropriate incentives in the contract, allows for the possibility of opportunistic behaviour in the form of moral hazard. We formulate two simple analytical models which demonstrate the effects of moral hazard in the market for network transport services. The first deals with the case where the network is contracted for short duration transport where the customer can not use the statistical information obtained during the life time of the service to determine with certainty the actual effort allocated by the network. The second model deals with transit contracts of longer duration, where the actual cost for provisioning the service at various quality levels is only statistically known at the time the contract is set up. Although these models are too simple for capturing the complexity of interconnection agreements between ISPs, they demonstrate the bad effects of information asymmetry and motivate the importance of incentive contracts for improving efficiency.