Adverse selection with pride, anger or fairness concerns Cécile Aubert University of Bordeaux (GREThA) Toulouse School of Economics (LERNA)

IAREP / SABE 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

IAREP / SABE 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).

IAREP / SABE 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.

IAREP / SABE – 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)

IAREP / SABE – 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  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.

IAREP / SABE 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.

IAREP / SABE – 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.

IAREP / SABE Concern for ‘fairness’… (cont’d) Concerns for fairness/envy would have an impact under complete information (as seen from q = q*(  )). The parameter for ‘envy’, , thus reduces complete information quantities, and hence the quantity for an efficient agent. A 2 nd effect of  is that it ultimately reinforces downward distortions due to information rents, despite a positive impact on incentives...

IAREP / SABE 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