Moral hazard and reciprocity.

• Author: Castillo, Marco

1. Introduction

   Since first introduced in the experimental literature, Berg, Dickhaut, and McCabe's (1995) investment game has consistently shown that people respond to kind actions with kind actions. The evidence that people trust and those entrusted tend to reciprocate generally holds across treatments and populations. (1) These results have been interpreted as evidence that positive reciprocity is an essential component of human behavior. However, there are concerns that evidence of reciprocity might be fragile (Cox and Deck 2005, 2006), sensitive to the experimental context (Levitt and List 2007), or an expression of reputational concerns (List 2006). This article investigates how the option to hide selfish behavior, or how moral hazard, affects reciprocity. Moral hazard is an interesting case study because it should affect neither altruistic motives nor reciprocity but affects the information one's actions reveal. (2)

   In the discrete trust game, Player 1 decides whether or not to pass an amount of money to Player 2. Any amount passed is increased by a factor larger than one. Player 2 decides whether to keep or share this increased amount of money. Not returning any money means that Player 1 earns nothing. The equilibrium of this game is for Player 2 to keep any money passed and for Player 1 not to pass any money at all. The observed behavior of Player 2 is puzzling because the decision is not strategic. Player 2 cannot influence game play because the game ends (in oneshot games) or subjects in the position of Player 2 face new proposers each time. (3)

   We study a modified discrete trust game that randomly allows Player 2 to make a decision 80% of the time. Twenty percent of the time, Player 2 can only keep the money passed by Player 1, if any. While both players know of this possibility, only Player 2 knows whether it is taking effect or not. The new game prevents Player 1 from knowing whether Player 2's behavior to keep money is intentional or not. (4) Since the incentives in the modified trust game are similar to those of the standard trust game, equilibrium predictions are unaffected. Player 2's intentions are only important if he has concerns about the feelings of Player 1 or concerns about the image Player 1 forms of him.

   Models of altruism and inequality aversion predict no change in behavior across treatments since Player 2 faces the same menu in both games. Guilt aversion predicts no variation across treatments because guilt is not dependent on others knowing the commission of an act. Reciprocity predicts that Player 2 must be more inclined to reciprocate in the modified game since Player 1 takes an extra risk on passing money to Player 2 in this game. The probability that Player 2 passes money back can decrease if Player 2 cares for Player l's feelings of betrayal or if Player 2 cares about the beliefs others have of himself. For instance, Charness and Dufwenberg (2006) show that reductions in reciprocity can be self-fulfilling: If increased anonymity reduces the expectation of reciprocity then it is easier not to reciprocate.

   Our results show that subjects in the role of Player 2 do not increase the frequency of returned money in the modified game. If anything, the evidence is consistent with a shift towards more selfish behavior. This, in turn, produces a significant decline in the amount of money passed by subjects in the role of Player 1 in the modified game. The standard game presents an increase in selfish actions as the game progresses. This suggests that reputational concerns are at play (Camerer and Weigelt 1988). The fact that the modified game produces more selfish behavior suggests that actions carry meaning, and that models with interdependent preferences (Levine 1998) or models where individuals derive utility from beliefs are important.

   Despite the fact that the behavior of players is affected by the level of anonymity of their actions, our results also show that trust and reciprocity persist. Behavior of subjects in the role of Player 2 in both games converges to a level of reciprocity significantly above zero.

   Research on reciprocal motives and fairness concentrates on the consequences of menus available to first movers on second movers' behavior (Kagel, Kim, and Moser 1996; Brandts and Sola 2001; Charness and Rabin 2002; Falk, Fehr, and Fischbacher 2003; Cox and Deck 2005). Our article studies second movers' behavior instead by directly manipulating their menus. (5) We believe that studying the robustness of second movers' behavior to available menus is important. Our study shows that the meaning of one's behavior is important to first as well as second movers. Indeed, simple introspection suggests that second movers might act upon concerns of the image they portray (to their partner or the experimenter) or about the feelings of proposers whose trust is betrayed (Bohnet et al. 2008).

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   The article is organized as follows. Section 2 presents the modified trust game and how it relates to theories of behavior in games. Section 3 describes the experiment and protocols. Section 4 presents the main results, and section 5 concludes.

2. Theory and Hypotheses

   Figure 1 illustrates the games used in the experiments. Figure la presents a standard trust game. Player 1 chooses either to keep the original endowment of $0.50 or to send it to Player 2. The $0.50 is multiplied by three before reaching Player 2. (6) Player 2 has to decide whether to keep the received $1.50 or to return 2/3, $1.00, of it. The payoffs if Player 2 keeps the money are $0.00 for Player 1 and $2.00 for Player 2. If $1.00 is returned, both players earn $1.00. This version of the trust game is special in that Player 2 has to decide between passing back 2/3 of the money received or nothing at all. Most evidence on trust games shows that subjects tend to return just enough to make Player 1 break even. We do not view this is as a disadvantage of the design since it will allow us to see Player 2's behavior when nonselfish behavior is costly.

   Figure 1b illustrates a modified version of the trust game. The main difference between the standard trust game and ours is that Nature randomly chooses whether Player 2 will be able to respond to Player 1. In particular, only 80% of the time is Player 2 allowed to respond to Player 1. Another important feature of the modified trust game is that Player 1 is unaware of whether the decision to hold was made by Nature or Player 2. Only decisions to pass reveal that Player 2 could choose and that he chose to return. (7) Finally, it is not irrelevant whether Player 2 cannot choose or Player 2's decision is reversed. In the second case, the implicit cost of reciprocity is affected. (8)

   The unique equilibrium of...