Adverse selection with pride, anger or fairness concerns

Cécile AubertUniversity of Bordeaux (GREThA)

Toulouse School of Economics (LERNA)

IAREP / SABE 2008 2

Introduction

Agents may have pride (feel anger) and thus refuse “bad” deals.

They may also have concerns for fairness (be envious) and resent the gains of their principal.

Incentives to report information?

Are the two types of concerns / feelings different in terms of prediction?

- Both pride/anger and fairness/envy affect participation, though differently.

- The standard downward distortion result may not hold.

Introduction

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Some references

• Ultimatum game: Camerer and Thaler (1995 JEcoPerspectives), Forsythe, Horowitz, Savin and Sefton (1994 GEB), …

Largely rejection of offers that are too low. Possibly because of fairness concerns.

Ben-Shakhar, Bornstein, Hopfensitz and van Winden (2007 JEcoPsy), Rotemberg (2007 JEBO): anger may explain rejection.

Kirchsteiger (1994 JEBO) : envy may explain rejection.

• Fairness concerns: Fehr and Schmidt (1999 QJE, 2007 Econometrica), etc.

• Envy: Dur and Glazer (2007 JLEO).

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Pride and ‘spitefulness’

We will consider 2 situations:

- The agent has ‘pride’ (or obeys norms of behavior, cares for reputation…): he refuses offers that are ‘too low’ w.r.t. the value created.

- The agent is concerned by ‘fairness’, or just spiteful/envious: he suffers a disutility when receiving a lower share of the value created than the principal.

To what extent does this modify incentives to mis-report under adverse selection?

Note: pride departure from the standard assumption that the principal has all the bargaining power.

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1 – The adverse selection model

The agent has private information on a cost parameter , with = with pr. , = otherwise.

(q) ≡ C(,q) – C(,q) > 0.

V(,q) ≡ S(q) – C(,q).

• ‘Pride’: U = t – C(,q) and A refuses offers that provide him with less than V(,q) Type-dependent, and endogenous, reservation utilities.

• ‘Fairness’: U = t – C(,q) – [(S(q) – t) – (t – C(,q))] Direct modification of incentives. A°: < 1/3.

P

A

(t)

W = E[S(q) – t]

U(t,, q)Costs C(, q)

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2 – Pride / anger

Define q* as full information quantity for a low-cost type, etc. The program of the principal is

Max [V(,q) – U] + (1 – )[V(,q) – U]

subject to

U V(,q) (IR)

U V(,q) (IR)

U U + (q) (IC)

U U – (q) (IC)

5 intervals, as in Lewis – Sappington (1989), but intervals directly depend, not only on , but also on quantities.

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Pride / anger (Cont’d)

Proposition:

− There is always (weakly) less downward distortion in quantities than in the absence of pride.

− Quantities may be distorted upwards, if the agent demands a large share of the surplus.

− Asymmetric information involves no inefficiency when the agent demands an ‘intermediate’ share, i.e.

Corollary:

Assuming that the principal has all the bargaining power may lead to overestimating inefficiencies caused by adverse selection.

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3 – Concern for ‘fairness’ / spitefulness

Program of P: Max [S(q) – t] + (1 – )[S(q) – t]

s.t. U 0 (IR)

U 0 (IR)

U U + (1-) (q) (IC)

U U – (1-) (q) (IC)

Very different from pride. Spitefulness (a high )

- ↑ the value of the transfer to the agent,

- ↓ the information rent of an efficient agent for a given q.

Transfers may however ↑ or ↓ compared to =0.

)(),()1()21(

),(),()21( ))],(())([(),(

qSqCtU

qVqCtqCttqSqCtU

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Concern for ‘fairness’… (cont’d)

Concerns for fairness/envy would have an impact under complete information (as seen from q = q*()).

)('31

)1)(21(

1

),(

31

21)('

),(

31

21)('

qq

qCqS

q

qCqS

The parameter for ‘envy’, , thus reduces complete information quantities, and hence the quantity for an efficient agent.

A 2nd effect of is that it ultimately reinforces downward distortions due to information rents, despite a positive impact on incentives...

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Conclusion

• Many fascinating problems arise in situations with several agents – possibly working in a team.

• But even in the simplest principal-agent setting, distortions in incentive arise.

- Feelings such as anger may increase social welfare (by reducing distortions due to asymmetric information), though not always.

- And the exact type of feelings considered matters.

Conclusion