An experimental investigation of trust and sequential trade.

• Author: Deck, Cary A.

1. Introduction

   To study a complex phenomenon, economists often reduce it to a tractable abstract problem. For example, the trust game of McCabe and Smith (2000) is a model of sequential trade with no external contract enforcement as described by Coricelli, McCabe, and Smith (2000). In the standard trust game, the first mover can decide to either end the game with both parties receiving $10 or continue the game with the total payoff increased to $40. If the first mover does not end the game, the second mover can decide to either keep the entire $40 or keep $25 and return $15 to the first mover. The first mover can be viewed as a stylized seller who incurs a $10 cost to provide an item valued by the buyer at $30 in exchange for a $15 payment.

   The voluntary trade is mutually welfare improving, but it requires the first party to forego something of value and risk not having the transaction completed; thus the first mover must trust that the second mover is trustworthy. (1) Behavior in the trust game is fairly robust; Cox and Deck (2005) and Gillies and Rigdon (2008) replicate the results of McCabe and Smith (2000). Approximately half of the first movers trust and about two-thirds of the second movers are trustworthy. However, second-mover behavior is sensitive to the level of social distance. Cox and Deck (2005) report a reversal of second-mover behavior when the experimenters could not identify who took what action using a double-blind protocol.

   What does behavior in the trust game say about behavior in naturally occurring trading opportunities? A comparison of the well-understood simplified version of the game and the original problem of interest identifies additional complicating features appropriate for further investigation in an attempt to answer this question. The trust game differs from naturally occurring trades in several ways. When people consider a trade, they weigh the gain from a successful trade against the loss from an unsuccessful one. (2) The price determines the size of the potential gain and loss. In the naturally occurring economy, prices are formed through some endogenous process; yet prices are exogenously fixed by the experimenter in the trust game. In the laboratory, payoff information is usually public; whereas in practice a seller does not know the willingness to pay of the buyer, nor does the buyer know the seller's cost. Experiments by McCabe, Rassenti, and Smith (1998) and Gillies and Rigdon (2008) demonstrate that the effect of payoff privacy is behavior more consistent with the traditional self-interested model than what is typically observed with public information. Further, previous trust game experiments have been intentionally abstract. Eckel and Grossman (1996) argue "...that social and psychological factors affect economic decision making, and the importance of social factors can only be introduced by abandoning, at least to some extent, abstraction" (p. 189). Direct evidence of the effect of a buyer-seller framing in the related ultimatum game is mixed (see Hoffman et al. 1994; Cox and Deck 2005). (3)

   This article moves towards a more complete story of sequential trade by imbedding endogenously determined variations of the trust game into a richer experimental environment with payoff privacy and buyer-seller framing. The next section details the experimental design and a separate section presents the behavioral results, which differ from previous work. A fourth section explores which factors cause the behavioral shift and a final section concludes.

2. Experimental Design and Procedures

   The experiments involve variations of the trust game and a related game where the order of play is reversed. In the standard trust game, the second-mover buyer providing payment makes a one for one transfer to the first-mover seller. When the order is reversed so that the buyer initiates trade, then the second-mover seller makes a one for three transfer to the first mover. The difference is that surplus is generated when the good is exchanged, but not when the payment is made. (4) Figure 1 describes the seller-first trust game (left panel) and the buyer-first modified trust game (right panel) in terms of endowments of the buyer and seller ([E.sub.B] and [E.sub.s], respectively), value to the buyer (V), cost to the seller (C), and the price (P). In the experiments, the induced value of the good was V = $15, and the induced cost of producing and "shipping" the good was C = $5. The buyer was endowed with [E.sub.B] = $15, and the seller was endowed with [E.sub.s] = $10. (5) As was explained to the subjects, all amounts are in U.S. dollars.

   [FIGURE 1 OMITTED]

   The experiment was framed as an opportunity for a buyer and seller to trade. The directions used the terms buyer, seller, value, cost, price, and so on. (6) The trust game was presented in extensive form with the branches labeled "Pay" and "Not Pay" for the buyer and "Ship" and "Not Ship" for the seller. Figure 2 shows an example screen for a buyer who is moving second. Payoff information was private. That is, a buyer knew her own endowment and value but not the endowment or cost of the seller. (7) Similarly, a seller knew his cost and endowment but not the buyer's value and endowment. As shown in Figure 2, buyers observed E and C, denoting the seller's endowment and cost. The buyer knew that her failure to pay resulted in the seller earning E - C while payment resulted in the seller receiving E - C + the price.

   Previous trust game experiments have assumed a fixed price. In the current experiments, prices were determined through a bargaining process. Subjects were randomly matched with someone in the opposing role and had five minutes to negotiate a price. During the bargaining process, subjects could adjust the game displayed on their screen to reflect any price between 0 and 25. Figure 2 shows the decision tree for a price of P = 5. There was no imposed order of offers, nor was there an improvement rule, but sellers could not suggest a price below the current price proposed by the buyer, nor could a buyer suggest a price above the current price proposed by the seller. Prices were required to be whole dollar amounts, and a no bankruptcy condition was imposed. Sellers could not post or agree to a price below C = $5, and buyers could not post or accept a price above V = $15, but this was private information. A contract was only reached when one party accepted the price put forward by the other party. If time expired without a contract being reached, both subjects received their respective endowments.

   [FIGURE 2 OMITTED]

   A price agreement depends upon the first mover's beliefs that the trade will be completed at that price as well as the potential payoffs associated with the price. If first movers anticipate that second movers are more likely to complete trades where the price favors the second mover, then first movers find themselves in a situation similar to a first price auction; one could ask for a larger but less likely payoff or one that is smaller and more likely. Such a belief is commonly expressed by the old adage that "if a deal looks too good to be true, then it probably is." At the same time, the second mover must agree to the negotiated price as well, and thus the price reflects the second mover's distributive preferences and intended action. A second mover that plans to defect would be willing to agree to any price but would want to act like a well-intentioned second mover so as not to arouse the suspicion of the first mover. Given the...