B01
Competition and Incentives
Discussion Papers

Discussion Paper No. 238
April 28, 2020

Selling Dreams: Endogenous Optimism in Lending Markets

Author:

Bridet, Luc (University of St Andrews)
Schwardmann, Peter (LMU Munich)

Abstract:

We propose a simple model of borrower optimism in competitive lending markets with asymmetric information. Borrowers in our model engage in self-deception to arrive at a belief that optimally trades off the anticipatory utility benefits and material costs of optimism. Lenders’ contract design shapes these benefits and costs. The model yields three key results. First, the borrower’s motivated cognition increases her material welfare, regardless of whether or not she ends up being optimistic in equilibrium. Our model thus helps explain why wishful thinking is not driven out of markets. Second, in line with empirical evidence, a low cost of lending and a booming economy lead to optimism and the widespread collateralization of loans. Third, equilibrium collateral requirements may be inefficiently high.

Keywords:

optimal expectations; motivated cognition; wishful thinking; financial crisis; lending markets; screening

JEL-Classification:

D86; D82; G33

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Discussion Paper No. 209
December 9, 2019

Delegation, Promotion, and Manager Selection

Author:

Häusinger, Benjamin (LMU Munich)

Abstract:

Promotions serve two purposes. They ought to provide incentives for employees and to select the best employee for a management position. However, if non-contractible managerial decision rights give rise to private benefits and preference misalignment between managers and the firm, these two purposes are in conflict. This is because the worker with the largest private benefit as a manager has the strongest incentives to work hard to get promoted. This article shows how the interplay of managerial decision rights and performance-based promotions leads to a situation often referred to as the Peter principle: employees that create lower expected profits as managers have yet better promotion prospects. That finding still holds when the firm owner optimally chooses the promotion rule, the degree of delegation, and wage payments to both employees and managers. To optimize organizational design, the firm balances better worker incentivization but worse manager selection by using performance-based promotions and restricting managerial decision rights.

Keywords:

peter principle; promotion; delegation of decision rights; incentives; manager selection; organizational design

JEL-Classification:

D02; L22; M51; M52

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Discussion Paper No. 197
November 7, 2019

Decision Making under Uncertainty: An Experimental Study in Market Settings

Author:

Echenique, Federico (California Institute of Technology)
Imai, Taisuke (LMU Munich)
Saito, Kota (California Institute of Technology)

Abstract:

We design and implement a novel experimental test of subjective expected utility theory and its generalizations. Our experiments are implemented in the laboratory with a student population, and pushed out through a large-scale panel to a general sample of the US population. We find that a majority of subjects’ choices are consistent with maximization of some utility function, but not with subjective utility theory. The theory is tested by gauging how subjects respond to price changes. A majority of subjects respond to price changes in the direction predicted by the theory, but not to a degree that makes them fully consistent with subjective expected utility. Surprisingly, maxmin expected utility adds no explanatory power to subjective expected utility. Our findings remain the same regardless of whether we look at laboratory data or the panel survey, even though the two subject populations are very different. The degree of violations of subjective expected utility theory is not affected by age nor cognitive ability, but it is correlated with financial literacy.

Keywords:

uncertainty; subjective expected utility; maxmin expected utility; revealed preference

JEL-Classification:

D01; D81; D90

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Discussion Paper No. 192
October 21, 2019

Procrastination and Learning about Self-Control

Author:

Christensen, Else (RBB Economics)
Murooka, Takeshi (Osaka University)

Abstract:

We study a model of task completion with the opportunity to learn about own self-control problems over time. While the agent is initially uncertain about her future self-control, in each period she can choose to learn about it by paying a non-negative learning cost and spending one period. If the agent has time-consistent preferences, she always chooses to learn whenever the learning is beneficial. If the agent has time-inconsistent preferences, however, she may procrastinate such a learning opportunity. Further, if her time preferences exhibit inter-temporal conflicts between future selves (e.g., hyperbolic discounting), the procrastination of learning can occur even when the learning cost is zero. The procrastination also leads to a non-completion of the task. When the agent has multiple initially-uncertain attributes (e.g., own future self-control and own ability for the task), the agent’s endogenous learning decisions may be misdirected — she chooses to learn what she should not learn from her initial perspective, and she chooses not to learn what she should.

Keywords:

procrastination; self-control; naivete; hyperbolic discounting; misdirected learning

JEL-Classification:

C70; D83; D90; D91

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Discussion Paper No. 168
July 30, 2019

Meta-Analysis of Present-Bias Estimation Using Convex Time Budgets

Authors:

Imai, Taisuke (LMU Munich)
Rutter, Tom (Stanford University)
Camerer, Colin (California Institute of Technology)

Abstract:

We examine 220 estimates of the present-bias parameter from 28 articles using the Convex Time Budget protocol. The literature shows that people are on average present biased, but the estimates exhibit substantial heterogeneity across studies. There is evidence of modest selective reporting in the direction of overreporting present-bias. The primary source of the heterogeneity is the type of reward, either monetary or non-monetary reward, but the effect is weakened after correcting for potential selective reporting. In the studies using the monetary reward, the delay until the issue of the reward associated with the "current" time period is shown to influence the estimates of present bias parameter.

Keywords:

present bias; structural behavioral economics; meta-analysis; selective reporting

JEL-Classification:

D90; C91

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Discussion Paper No. 139
February 23, 2019

Learning About One’s Self

Authors:

Le Yaouanq, Yves (LMU Munich)
Schwardmann, Peter (LMU Munich)

Abstract:

How can naivete about present bias persist despite experience? To answer this question, our experiment investigates participants' ability to learn from their own behavior. Participants decide how much to work on a real effort task on two predetermined dates. In the week preceding each work date, they state their commitment preferences and predictions of future effort. While we find that participants are present biased and initially naive about their bias, our methodology enables us to establish that they are Bayesian in how they learn from their experience at the first work date. A treatment in which we vary the nature of the task at the second date further shows that learning is unencumbered by a change in environment. Our results suggest that persistent naivete cannot be explained by a fundamental inferential bias. At the same time, we find that participants initially underestimate the information that their experience will provide - a bias that may lead to underinvestment in experimentation and a failure to activate self-regulation mechanisms.

Keywords:

naivete; present bias; learning

JEL-Classification:

D83; D90

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Discussion Paper No. 133
December 20, 2018

Bayesian Implementation and Rent Extraction in a Multi-Dimensional Procurement Problem

Authors:

Herweg, Fabian (University of Bayreuth)
Schmidt, Klaus (LMU Munich)

Abstract:

We consider a multi-dimensional procurement problem in which sellers have private information about their costs and about a possible design flaw. The information about the design flaw is necessarily correlated. We solve for the optimal Bayesian procurement mechanism that implements the efficient allocation under the constraint that sellers are protected by limited liability. We show that the rents obtained from reporting costs truthfully can be used to reduce the rents sellers must get for reporting the flaw. We compare the optimal Bayesian mechanism to the optimal ex post incentive compatible mechanism that is informationally less demanding.

Keywords:

auctions; correlated types; inefficient renegotiation; multidimensional screening; procurement;

JEL-Classification:

D44; D47; D82; H57;

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Discussion Paper No. 120
October 11, 2018

Communicating Subjective Evaluations

Author:

Lang, Matthias (LMU Munich)

Abstract:

Consider managers evaluating their employees' performances. Should managers justify their subjective evaluations? Suppose a manager's evaluation is private information. Justifying her evaluation is costly but limits the principal's scope for distorting her evaluation of the employee. I show that the manager justifies her evaluation if and only if the employee's performance was poor. The justification assures the employee that the manager has not distorted the evaluation downwards. For good performance, however, the manager pays a constant high wage without justification. The empirical literature demonstrates that subjective evaluations are lenient and discriminate poorly between good performance levels. This pattern was attributed to biased managers. I show that these effects occur in optimal contracts without any biased behavior.

Keywords:

communication; justification; subjective evaluation; centrality; leniency; disclosure

JEL-Classification:

D82; D86; J41; M52

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Discussion Paper No. 109
August 2, 2018

Consumer Exploitation and Notice Periods

Authors:

Murooka, Takeshi (Osaka University)
Schwarz, Marco (University of Innsbruck)

Abstract:

Firms often set long notice periods when consumers cancel a contract, and sometimes do so even when the costs of changing or canceling the contract are small. We investigate a model in which a firm offers a contract to consumers who may procrastinate canceling it due to naive present-bias. We show that the firm may set a long notice period to exploit naive consumers.

Keywords:

notice periods; procrastination; present bias; time inconsistency; consumer naivete

JEL-Classification:

D04; D18; D21; D40; D90; L51

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Discussion Paper No. 103
June 26, 2018

Approximate Expected Utility Rationalization

Authors:

Echenique, Federico (California Institute of Technology)
Imai, Taisuke (LMU Munich)
Saito, Kota (California Institute of Technology)

Abstract:

We propose a new measure of deviations from expected utility, given data on economic choices under risk and uncertainty. In a revealed preference setup, and given a positive number e, we provide a characterization of the datasets whose deviation (in beliefs, utility, or perceived prices) is within e of expected utility theory. The number e can then be used as a distance to the theory. We apply our methodology to three recent large-scale experiments. Many subjects in those experiments are consistent with utility maximization, but not expected utility maximization. The correlation of our measure with demographics is also interesting, and provides new and intuitive findings on expected utility.

Keywords:

expected utility; revealed preference

JEL-Classification:

D01; D81

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