Strategic sophistication of individuals and teams. Experimental evidence

Many important decisions require strategic sophistication. We examine experimentally whether teams act more strategically than individuals. We let individuals and teams make choices in simple games, and also elicit first- and second-order beliefs. We find that teams play the Nash equilibrium strategy significantly more often, and their choices are more often a best response to stated first order beliefs. Distributional preferences make equilibrium play less likely. Using a mixture model, the estimated probability to play strategically is 62% for teams, but only 40% for individuals. A model of noisy introspection reveals that teams differ from individuals in higher order beliefs.     

Pricing, learning, and strategic behavior in a single-sale model

Summary. We analyze an infinite horizon model where a seller who owns an indivisible unit of a good for sale has incomplete information about the state of the world that determines not only the demand she faces but also her own valuation for the good. Over time, she randomly meets potential buyers who may have incentives to manipulate her learning process strategically. We show that i) the seller's incentives to post a high price and to experiment are not necessarily monotonic in the information conveyed by a buyer's rejection; and ii) as the discount factors tend to one, there are equilibria where the seller always ends up selling the good at an ex-post individually rational price. Received: January 6, 1999; revised version: July 15, 2000     

Strategic Manipulation and Information Market Microstructure

This paper presents a model of strategic manipulation in the context of an informational duopoly. The fact that market manipulation by these duopolists may affect their cost and demand structures implies that they can strategically manipulate the market in order to influence the information market equilibrium. This paper derives an equilibrium manipulation and establishes important comparative-static properties that may characterise such markets. The informational duopoly is beset with two types of inefficiency: first, market imperfections drive a wedge between the marginal cost and the market price leading to the usual deadweight loss. Secondly, an act of manipulation raises the marginal cost of production and, thereby, causes further welfare loss in such markets. We provide a complete characterisation of an optimal mechanism that can stem the welfare loss in informational markets.     

Asymmetric information, signaling and environmental taxes in oligopoly

This paper examines the effects of signaling on environmental taxation in a two-period oligopoly model in which each firm privately knows whether its technology is clean or dirty, while third parties (the rival firms and the regulator) have only a subjective perception about this fact. Consequently, there are both horizontal and vertical asymmetric information, and each firm can strategically manipulate both, the competitor's and the regulator's priors. In this context, we find that each firm wishes to be perceived as a technologically clean firm in period 2 whenever the regulator's ecological conscience is sufficiently high. We also show that taxes under symmetric information are always positive, but under asymmetric information and signaling they may be negative (subsidies) and lower or greater than in the symmetric information case, depending on the ecological conscience of the regulator and the probability of firms being dirty. Finally, taxes are below environmental marginal damage, both under symmetric and asymmetric information, and signaling reinforces such under-taxation.     

Cooperation and framing effects in provision point mechanisms: Experimental evidence

Andreoni (1995) showed that pure framing effects may influence contribution in Voluntary Contribution Mechanisms (VCM) by comparing a standard public goods game, called the positive frame condition (giving to the public good), with a negative frame condition (taking from the public good) where the subjects' choice to purchase a private good makes the other subjects worse off. This paper aims at testing the robustness of such framing effects in the context of Provision Point Mechanisms (PPM). Our approach is original in that it combines both framing and provision point dimensions by comparing maintaining (taking from the public good) and creating (giving to the public good) contexts using Provision Point experiments. Consistent with previous findings, we find that individuals tend to be less cooperative in the maintaining frame than in the creating frame. Our results also show that the framing effects are stronger under a PPM than under a VCM and increase with the provision point level. These results may have important consequences for the management of environmental resources.     

The impact of labour unions on external auditor selection and audit scope: evidence from the Korean market

We examine whether labour unions influence external auditor selection and audit scope. As a major user group of financial information, labour unions likely demand financial information of high quality and thus high-quality audits. As a union’s request for wage increases is likely strong when a firm is performing well, management facing wage negotiations with the labour union has incentives to manipulate earnings downward and may therefore prefer auditors who allow more discretion. Using union data unique to Korea during 2005–2008, we find that firms with a stronger labour union tend to choose higher-quality auditors (i.e. Big N or industry specialist auditors). We also find that unionization is negatively (positively) associated with positive (negative) abnormal audit fees and audit hours, and the effects are more pronounced when the union is stronger and more active. Given that departures from normal audit fees and audit hours in either direction arguably impair audit quality, this finding is consistent with our prediction of unions’ demand for high-quality audits. Overall, our findings suggest that labour unions play an important role in determining audit quality.     

DO GOOD OR DO WELL? PUBLIC DEBT MANAGEMENT IN A TWO-PARTY ECONOMY*

Governments facing elections may strategically manipulate policy instruments in order to increase their re-election chances. The incentives for strategic manipulation are studied in the context of a debt management model, in which two parties with different inflation aversion compete in elections. It is shown that the inflation-averse party may issue nominal debt in order to make its opponent “look bad” to voters, thus getting closer to the median voter. Nominal debt artificially enlarges the ex-post inflation tax base, causing higher inflation. Conversely, an inflation-prone government may issue indexed debt in order to reduce inflation incentives.     

Anti-herding and strategic consultation

In this paper I analyze how careerist decision makers aggregate and use information provided by others. I find that decision makers who are motivated by reputation concerns tend to ‘anti-herding’, i.e., they excessively contradict public information such as the prior or others’ recommendations. I also find that some decision makers may deliberately act unilaterally and not consult advisers although advice is costless. Moreover, advisers to the decision maker may not report their information truthfully. Even if the advisers care only about the outcome, they bias their recommendation since they anticipate inefficient anti-herding behavior by the decision maker.     

A theory of reciprocity

People are reciprocal if they reward kind actions and punish unkind ones. In this paper we present a formal theory of reciprocity. It takes into account that people evaluate the kindness of an action not only by its consequences but also by its underlying intention. The theory is in line with the relevant stylized facts of a wide range of experimental games, such as the ultimatum game, the gift-exchange game, a reduced best-shot game, the dictator game, the prisoner's dilemma, and public goods games. Furthermore, it predicts that identical consequences trigger different reciprocal responses in different environments. Finally, the theory explains why outcomes tend to be fair in bilateral interactions whereas extremely unfair distributions may arise in competitive markets.     

High-school genetic diversity and later-life student outcomes: micro-level evidence from the Wisconsin Longitudinal Study

A novel hypothesis posits that levels of genetic diversity in a population may partially explain variation in the development and success of countries. Our paper extends evidence on this question by subjecting the hypothesis to an alternative context that eliminates many competing hypotheses. We do this by aggregating representative individual-level data for high schools from a single US state (Wisconsin) in 1957, when the population was composed nearly entirely of individuals of European ancestry. Using this sample of high school aggregations, we too find a strong association between school-level genetic diversity and a range of student socioeconomic outcomes. Our use of survey data also allows for a greater exploration into the potential mechanisms of genetic diversity. In doing so, we find positive associations between genetic diversity and indexes for openness to experience and extraversion, two personality traits tied to creativity and divergent thinking.     

Differences in the response heterogeneity of educational attainment and achievement to the same instrumental variable

The typical econometric application of instrumental variable (IV) estimates imposes a constant-treatment-effect model for all individuals. Using regression discontinuity design, we find while older school starters tend to have lower educational attainment, they are more likely to achieve qualifications at different educational levels for the UK. This finding joins the discussion on instruments for educational outcomes by offering some evidence that school starting age can affect treated individuals diversely. We highlight that identifying the treatment effect with methods similar to IV estimates should be concerned in the context of heterogeneous treatments; that is, the instrument in question has an effect on treatment for particular subpopulations only, and those subpopulations may not be the same for different treatments.     

Individual incentives in the supply of public inputs

The free-rider hypothesis states that, in the decision on public-goods and private-good provision, individual incentives are such that public goods will tend to be undersupplied. This paper examines the free-rider argument as it applies to public intermediate goods. It is shown that, unlike in a static model, in a dynamic world there may exist incentives for firms to act cooperatively in determining the supply of public intermediate goods. In a dynamic context there is a cost to free riding: what one firm does now affects what others will do in the future. Provided future profits are not discounted too heavily, the free-rider problem may disappear when a time dimension is added to the theory.     

SHORT‐RUN POLICY COMMITMENT WHEN INVESTMENT TIMING IS ENDOGENOUS: ‘MORE HARM THAN GOOD?’

In our model, firms choose when to set cost‐reducing investment and the government, which only has short‐run commitment power, sets an output subsidy. We show that firms that delay investment without government intervention have an incentive to invest early under policy activism, strategically underinvesting or overinvesting to obtain larger subsidies. The policy scheme thus creates a new, potentially more harmful, distortion. Under oligopoly, a firm has a weaker incentive to manipulate policy than under monopoly, which makes policy intervention less harmful. We investigate when the government may do better by adhering to laissez‐faire than by engaging in active policy intervention.     

Sick of being “Activated?”

Do unemployment insurance (UI) benefit recipients take sick leave more often when facing “activation” by the employment office? We answer this question using administrative data from the German Federal Employment Agency on vacancy referrals sent to UI benefit recipients. Applying duration analysis, we find an increased transition rate into short-term sick leave among individuals who had received vacancy referrals from the employment office. We find that while men on average report less sick compared to women, they respond stronger to a vacancy referral. In subsequent steps, we test the hypothesis that the results are driven by real illnesses as opposed to shirking. Our findings do not support this hypothesis. We interpret the findings as evidence of moral hazard behavior and as evidence of a side effect of an activation measure.     

Mass media and preferences for redistribution

This paper investigates how mass media potentially act on preferences for redistribution. Our hypothesis is that media contribute to shaping the value system of a person, which affects support for redistribution. A theoretical model is proposed which combines demand- and supply-driven media bias. On the demand side, the model considers two types of individuals: non-partisan, whose values are influenced by the media, and partisan, who have strong opinions not affected by the media. We assume that although partisan individuals prefer unbiased information, they hold beliefs that they like to be confirmed; therefore, they tend to consume media with an ideological position similar to theirs. On the supply side, we focus on interest groups’ pressure on media coverage. Our results suggest that the anti-equality lobby is willing to pay more than the competing lobby. Moreover, we show that media bias is a decreasing function of the advertising revenues and an increasing function of the relative weight of ideology vs pluralism in individuals’ demand for media. Adding a second media outlet reduces the likelihood of media bias but not its extent. Finally, if both lobbies are active, the two outlets’ ideological positions are polarised.     

The economic effects of constitutions: do budget institutions make forms of government more alike?

According to an influential theoretical argument, presidential systems tend to present smaller governments relative to parliamentary countries because the separation between those who decide the size of the fiscal purse and those who allocate it creates incentives for lower public expenditures. In practice, however, presidential and parliamentary countries come in many forms. In particular, variation in procedural rules that assign budget prerogatives across the popular branches of government may affect the underlying incentives that differentiate these types of regimes in terms of fiscal outcomes. More specifically, we argue that more hierarchical rules that concentrate budgetary power in the executive relative to the legislature do not only reduce the extent of the common pool problem but also limit the degree of separation of powers, which may have a countervailing effect. Consequently, the effect of the form of government on public expenditures is conditional on specific procedural rules. We test this hypothesis on a broad cross-section of countries and find that presidentialism has a negative impact on government size only when executive discretion in the budget process is low (that is, in a context of separation of powers). However, the negative effect of presidentialism on expenditures vanishes when the executive’s discretion over the budget process is higher. This result, in addition to highlighting that not all budget institutions have the same effect on incentives and outcomes, points out how important it is to go beyond broad characterizations of political institutions for explaining policy outcomes, and more generally, for moving forward the research agenda in constitutional political economy.     

Conformity and the Demand for Environmental Goods

The existing literature on eco-labeling and green consumerism has been framed within a classical market context where price and quality are the drivers of consumer choice. However, it seems possible that consumers are also concerned about the choices made by other consumers. In fact, it is unclear that people’s consumption decisions are made independently of social context. For instance, under the desire to conform to certain social norms—or in the presence of status concerns—some individuals may be willing to pay a higher price premium for green products the more widespread green consumerism is in society. We test this hypothesis using a choice experiment where the respondents were asked to choose among coffee products varying with respect to their share of ecological beans, share of fair trade beans, and price. Three treatments were used, differing only in the information given about the choices made by other consumers. We find different responses to the treatments across individuals and we can only confirm our hypothesis of conformity for women, although men appear to have stronger preferences for ecological coffee than women have.     

The control of game form recognition in experiments: understanding dominant strategy failures in a simple two person “guessing” game

This paper focuses on instructions and procedures as the reasons that subjects fail to behave according to the predictions of game theory in two-person “guessing game” (beauty contest game) experiments. In this game, two individuals simultaneously choose a number between 0 and 100. The winner is the person whose chosen number is the closest to 2/3 of the average of the two numbers. The weakly dominant strategy is zero. Because of the simplicity of the game, the widespread failure of subjects to choose the weakly dominant strategy has been interpreted as evidence of some fundamental inability to behave strategically. By contrast, we find that subjects’ behavior reflects a lack of understanding of the game form, which we define as the relationships between possible choices, outcomes and payoffs. To a surprising degree, subjects seem to have little understanding of the experimental environment in which they are participating. If subjects do not understand the game form, the experimental control needed for testing game theory is lost. The experiments reported here demonstrate that the failure to act strategically is related to how the game is presented. We test how well subjects are able to recognize the game under a variety of different presentations of the game. Some subjects fail to recognize the game form when it is presented abstractly. When the game is transformed into a simple isomorphic game and presented in a familiar context, subjects do choose weakly dominant strategies. While our results confirm the ability of subjects to make strategic decisions, they also emphasize the need to understand the limitations of experimental subjects’ ability to grasp the game as the experimenter intends. Given these limitations, we provide suggestions for better experimental control.     

The Paradoxical Behavioral Effects of a Directional Goal on Investors' Risk Perceptions and Valuation Judgments

Market participants who evaluate risk often have a preference or goal for positive company performance. The authors test how such a directional goal affects risk perceptions and the relation between risk perceptions and assessments of value in an investment context. Compared with investors without directional goals—who, consistent with prior behavioral research, focus on negative aspects of risk—the authors find that those with directional goals assess risk as being more symmetric (i.e., they are less focused on downside risk). However, investors with directional goals are also less likely to consider risk when assessing value. Taken together, these results suggest that a directional goal reduces one behavioral effect identified in prior literature (the tendency to focus on downside risk), but creates another behavioral effect (ignoring risk in assessing value). The authors discuss implications for standard setters and regulators seeking to communicate risk information to market participants.     

Entry Solicitation and Deterrence in R&D Competition with Spillovers

The purpose of this note is to examine incumbent behaviour and patterns of entry under R&D competition with spillovers. We find that, in addition to blockading, deterring and accommodating entry, the incumbent may also solicit entry. Entry solicitation occurs when the incumbent strategically alters its R&D commitment in order to take advantage of the spillover generated by the entrant's subsequent R&D investment. Although our results are placed in the context of R&D with spillovers, they are applicable to a wider class of models involving positive externalities, particularly network externalities.
JEL Classification Numbers: L12, O31.