1. Punishment and Norm Compliance Daniel Houser Professor of Economics Director, Interdisciplinary Center for Economics Science George Mason University, Fairfax, VA

2. motivation Sanctions are widely used to enforce cooperation and solve asymmetric information problems. Evidence shows that people do not always act to avoid punishment. Two primary reasons: Incentive effects and Intention effects.

3. related studies Detrimental Incentive Effects: Extrinsic incentive tends to reduce intrinsic motivation Frey and Oberholzer-Gee,1997 Deci, et al, 1999 Gneezy and Rustichini, 2000 Intention Effects: Imposing sanctions can be seen as a signal of distrust. Fehr and Falk, 2002 Intentions play an important role in shaping decisions. Rabin, 1993 McCabe, Rigdon and Smith, 2003

4. incentive effects Frey and Oberholzer-Gee (1997) Survey Swiss government intends to build two repositories to store nuclear waste. Two adjacent communities have been designated as potential sites. In 1993, 305 interviews. Ask respondents if they were willing to permit the construction of a nuclear waste repository of short-lived, low- and mid- level radioactive waste on the grounds of their community. Either no compensation, or compensation of $2,175 to $4,350 for all residents in community.

6. incentive effects Gneezy and Rustichini (2000) 160 students at University of Haifa were asked to answer a set of 50 questions taken from a IQ test. Group 1: answer questions as they could Group 2: 0.1 NIS for each correct answer. Group 3: 1 NIS Group 4: 3 NIS

8. incentive effects Gneezy and Rustichini (2000) Donation experiment: collect donations. 180 high school children in Israel. Group 1: no payment Group 2: pay 1% of the amount collected Group 3: pay 10% of the amount collected

10. intention effects McCabe, Rigdon and Smith (2003): Outcome-based model: inequality aversion. Intention-based model: players reading each other’s motivation. Depending on the available alternatives, identical outcomes may be interpreted differentially. (not the case in outcome-based model)

12. Intention Effects Nelson (2002) Standard ultimatum game($20) vs. truncated ultimatum game (maximum offer is limited to $4)

14. Houser, Xiao, McCabe and Smith (2008) Goal: Assess the importance of incentives and intentions in cases where punishment does not promote norm compliance.

15. experiment design Intention Treatment. (Intention + Incentive) Punishment is intentionally imposed by subjects. Random Treatment. (Incentive) Punishment is randomly imposed by nature Severity of Punishment. (Endogenously determined) Weak punishment: Punishment level<<cooperation cost Severe punishment: Punishment level>cooperation cost

18. subjects’ comments (no sanction) “ I did not return the desired amount, but I did return to Actor 1 (investor) the amount he/she transferred. Though I could have kept all the money. I suspect I would feel guilty about it…. The decision by Actor 1 not to impose the payoff cut definitely influenced me to give him/her back some of the money. Since the penalty is purely punitive.. I would not have any feeling of guilt about not sharing the money.” “I gave Actor 1 $5 and they had asked for $6…had they imposed the payoff cut, I would have transferred $0 back and paid the $4 fee because it would have cost me less.” “I sent back ½ of what they wanted so they ended up getting something…” (Random)

19. subjects’ comments (sanction) “…I would make less if I return her desired amount….if she/he didn’t choose the payoff cut I would send back some money to her.” “…I was assigned the cut, however, by them requesting 20E$ back, it was better off for me to give them nothing and pay my 4E$ fee”.

20. results Punishment incentives matter most Mean returns change under the threat of punishment, and in the same way regardless of whether the punishment was chosen by the investor or by nature. The amount transferred does not affect the percentage of tripled amount returned.

21. Return Percentage of Tripled Investment Amount (Intention vs. Random)* (Request≥8) Low Request * At least 20 observations in each cell. Excludes cases where request > 2/3 investment. (Request<8) High Request

22. results Punishment: get what you want or nothing at all When not threatened with punishment, the most common decision is to return something but not everything requested. This behavior is least common under threats of punishment.

23. Not punishedPunishedNot punishedPunished Low RequestHigh Request Distribution of Cooperative Types Complete Defection (Return=0) Middle (0<Return<Request) Complete Cooperation (Return>=Request) Percentage Severe punishmentWeak punishment

24. discussion Cooperation is more likely under threats of severe punishment. But severe punishment can be difficult to enforce, and consequently not credible, outside of the laboratory. Weak punishment is credible but risky: it can have detrimental effects on human cooperation. Why does punishment fail to promote cooperation? Our results suggest incentives can crowd-out norm based social motivations. Imaging study could shed important light on this issue

25. Li, Xiao, Houser and Montague (2008) Neuroeconomic investigation of why punishment fails to promote cooperation in a particular trust and reciprocity context. Provide evidence on the “perception shift” (framing/crowding out) explanation for the failure of weak sanctions to promote cooperation. Adding sanction threats to a social environment creates a business environment that promotes self- interested decision making.

26. neuroeconomics evidence Sanfey et al (2003) de Quervain et al (2004) Knoch et al (2006) All involve neural activity associated with the punishment decision Spitzer et al (2007) Neurocorrelates of punishment threats that promote norm compliance.

28. hypothesis When sanctions are not imposed, (social) reward system will be active in making decisions VMPFC (McCabe, et al 2001) LOFC (Montague and Lohrenz, 2007; Spitzer et al, 2007) Amygdala PCC (McClure et al, 2004) When sanctions are imposed, social reward system will be relatively less active, and parietal areas will be relatively more active (Platt and Glimcher, 1999)

29. fMRI design Use Fehr and Rockenbach design Two subjects anonymously matched, one as investor and one as trustee Play game 10 times Only trustee is scanned

30. Figure 1 Investor’s request trustee’s repayment sanction no sanction Investor’s investment (out of $10) free response investment made repayment made ~ 18 s request made sanction option selected ~ 8 s ~ 16 s free response free response free response ~ 28 s

31. Timeline Investment Made Repayment Made 8s free response free response Investment Cue Repay Cue 8s free response Request Cue Totals revealed Threat Cue free response 8 s Request Made Whether Sanction Decided KeptGave 3 7 investrequestsanction / no sanction ? Gave 7 Kept 14 repayment SOM Figure 2

32. data 104 participants, 52 Investors and 52 Trustees For Trustees: Ages 18-35, mean age 25 25 females Normal or corrected vision No neurological or psychiatric conditions No brain abnormalities

33. Table 1 Average behavior and payoff of investors and trustees SanctionNo-sanctionSignificance Investment Request/(3*Investment) Request Repayment Repayment/(3*Investment) Repayment/Request Investor’s Payoff Trustee’s Payoff 4.897.09* 10.0613.89-- 0.720.64 * 6.0512.04-- 0.460.55* 0.670.89* 11.5814.95* 17.0119.22-- * Indicates statistically significant

34. 0 5 10 15 20 25 0246810 Profit-split investor’s request in sanction condition Investor’s request in no sanction condition 0 5 10 15 20 25 0246810 investment-split repayment in sanction condition repayment in no sanction condition Money unit Investment A B Figure 2 Results

35. Brain responses differentially activated in sanction vs. no-sanction situations Region of activation X Y Z voxels Z peak MNI coordinates Parietal Lobe (L)-24-60 52723.99 Parietal Lobe (R) 28-48 40814.13 Inferior Temporal Gyrus-44-68 -4674.10 Temporal Lobe 28-68 20273.29 Precentral Gyrus (R) 44 -4 36683.97 Precentral Gyrus (L)-44 -8 36803.79 Fusiform Gyrus (R) 36-48-16183.63 Medial Gyrus -8-24 68173.30 Midbrain 4-12-12594.17 Cerebellum24-48-36444.19 threat – non-threat Regions with 5 or greater significant voxels were identified using T-test, p<0.005(uncorrected). Table 3 Parietal Regions More Active when Sanctions Threatened

36. no-sanctionsanction % signal change time (s) 04812 -.1 0.1.2 A B X = 4 Z = -4 VMPFC Y = 0 Amygdala T 501 PCC LOFC VMPFCLOFCAmygdalaPCC Figure 3 Social Reward Networks Active when Sanctions not Threatened

37. Figure 4 B Y = 56 -0.2 0.0 0.2 0.40.60.81.0 no sanction sanction % change of VMPFC activity repayment ratio A -0.1 0 0.1 0.2 0.40.60.81.0 % change of DLPFC activity repayment ratio Z = 16 Trustees’ Brain Regions Exhibiting Parametric Correlation Backtransfer Amount

38. conclusions Credible threats of sanctions perhaps generate a “cognitive shift” that diminish social motivations and promote selfish behaviors Absent sanctions, our data show a consistent activation pattern in areas previously been linked to social reward processing: LOFC, VMPFC, Amygdala. Imposing sanctions suppresses the social network and parietal areas play a greater role in decision making. Regardless of sanctions, activation in VMPFC correlates positively with trustee altruism. The sanction/no-sanction signal modulates baseline activity of VMPFC, but does not affect the correlation.