Area Conferences 2012

Transcription

1 A joint initiative of Ludwig-Maximilians University s Center for Economic Studies and the Ifo Institute CESifo Conference Centre, Munich Area Conferences 2012 CESifo Area Conference on Behavioural Economics 2 3 November Can Contracts Signal Social Norms? Experimental Evidence Anastasia Danilov and Dirk Sliwka CESifo GmbH Poschingerstr Munich, Germany Tel.: +49 (0) Fax: +49 (0) office@cesifo.de

2 Can Contracts Signal Social Norms? Experimental Evidence Anastasia Danilov and Dirk Sliwka* First Version: July, We investigate experimentally whether the choice of an incentive scheme can signal a social norm, when the principal is better informed about past actions of a broader number of other agents and the agent is aware of this. The principal can choose between a fixed wage ( trust contract ) and performance pay ( contingent contract ). She is matched to an agent who then determines his effort. We find that indeed agents react differently to identical contract choices when they know that the proposing principal is informed about prior efforts of other agents in an identical situation. Agents exert significantly higher effort under a fixed wage contract when knowing that the principal proposed this contract being aware of others reaction to it.. * Department of Personnel Economics and Human Resource Management, University of Cologne, Albertus-Magnus-Platz, Cologne, Germany. dirk.sliwka@uni-koeln.de. 1

3 1. Introduction In recent years the notion that social norms matter for behavior has gained considerable attention also in economics. 1 Indeed, there is now substantial evidence that individuals are affected in their choices by observed behavior of others in the same situation. 2 Many individuals tend to avoid deviations from prevalent norms of behavior, for instance, as these deviations may cause negative emotions such as remorse or shame. But often individuals are faced with situation where there is uncertainty about the prevalent norms. For instance, an employee who has just joined an organization may be uncertain about the expected efforts and working time or whether it is acceptable to surf the internet in the office, to what extent it is expected to support colleagues and so on. A very natural reaction for this employee should be to gather information about the behavior of others in the same situation to detect a potential norm of behavior. This may be easy for observable actions (such as working time), it may, however, be very difficult for other unobservable actions which are crucial for the performance of the organization (such as productively spend working time). And even after several years in an organization employees may for some actions be unable to judge with complete certainty about the behavior of their colleagues and may be influenced by additional information about this behavior. On the other hand, owners or managers in an organization often have means to collect more information about behavior. This information can be generated by active monitoring, but even when information about individual behavior is not 1 See for instance Akerlof (1980), Elster (1989), Bernheim (1994), Lindbeck et al. (1999), Kübler (2001), Fehr, Fischbacher and Gächter (2002), Fehr and Fischbacher 2004a or Fischer and Huddart (2005). See Young (2008) for an overview. 2 Examples are Ichino and Maggi (2000), Clark (2003), or Stutzer and Lalive (2004). 2

4 available, sometimes average behavior can be inferred from other sources such as accounting key figures. From this perspective owners of an organization may decide to regulate behavior based on observed actions for instance by setting incentives or restricting choice sets. But an important effect of these kinds of regulations is sometimes overlooked, namely, that these interventions may convey information about the prevalent norms in an organization and this in turn can have an indirect effect on behavior as perceptions about the behavior of others are altered. In this paper we investigate this effect in two economic lab experiments. In our first baseline treatment we implement a very simple principal agent game. The principal can choose between a fixed wage ( trust contract ) and performance pay ( contingent contract ). Each principal is matched to an agent who then determines his effort. We elicit the agents efforts for both contact types by the strategy method. In the second norms treatment we implement exactly the same game with a different set of subjects. We just make one addition: we show the principals a table of the efforts chosen by the agents in one session of the baseline experiment and inform the agents that their principals have seen this table without showing the agents the contents of the table. Hence, the treatment intervention is very weak on the agents side: they do not have more direct information about the behavior of others but they know that the principal had this information prior to her contract choice. It turns out that this minor treatment variation has a substantial effect on the chosen efforts under the fixed-wage contract: they are roughly 50% higher than in the baseline-treatment (52.9 instead of 35.4 in an interval between 0 and 100). Hence, when agents learn that principals had access to information about the behavior of other (here completely unrelated) agents in the same situations they react very differently in an economically identical situation. 3

5 In a second experiment we investigated the direct effect of the contract choice on beliefs about the information observed by the principals prior to that choice. In an online experiment we told participants a contract choice of a particular principal in the norms treatment of the first experiment. We then asked them to estimate the information principals had received prior to that choice, i.e. the average efforts observed by this principal for both contract types. Payments were contingent on the accuracy of this estimate. In one treatment subjects had to estimate the information observed by one randomly drawn principal who actually chose a trust contract. In another treatment subjects had to estimate the same for a principal who proposed a contingent contract. We find that beliefs about the prior information of a principal are indeed substantially affected by the knowledge of the principal s contract choice. Theoretical basis for our key hypothesis is a model by Sliwka (2007). In this model a certain fraction of agents are conformists and their behavior is influenced by their beliefs about the behavior of others. In contrast to steadfastly fair or steadfastly selfish individuals, conformists behave socially if they believe that the majority of other agents do so. When conformists are unable to observe behavior of others directly, they can infer the social norm from signals such as the contract choice by a principal who has more information about the distribution of types in the organization. It is shown that indeed separating equilibria may exist in which the principal s choice reveals this information. In particular, when a principal proposes a fixed wage contract, she is apparently confident that most agents will not shirk and in turn the conformists propensity to shirk is reduced. On the other hand, the choice of a performance contingent contract reveals the principal s pessimism about the behavior of the agents and in turn increases the 4

6 conformists willingness to shirk. 3 As there are always selfish individuals around signaling by choosing a fixed wage is costly to the principal. But principals who have observed that the number of selfish guys is small have lower costs and this can make the signal credible. The remainder of the paper is organized as follows: In section 2 we describe the experimental design and the procedure. In section 3 we present the results. In section 4 we present a further experimental study we conducted to get deeper insight into the effect of the contract form on agents beliefs. Section 5 concludes. 2. Experimental Design and Procedure The experiment has been conducted in the Laboratory for Experimental Research of University of Cologne. In total 120 participants (most of them students) were recruited via ORSEE (Greiner 2004). The instructions were displayed on the screens and participants were encouraged to ask questions privately. Before subjects made their decisions they had to complete a short quiz on the structure of the experiment and the computation of payoffs. All decisions were made anonymously and no communication was permitted during the experiment. Subjects were matched in pairs and randomly assigned roles of employee and employer. At the beginning of the experiment all participants received an endowment of 6. They then played a simple one-shot principal-agent game. Each employer could choose between either fixed wage ( trust contract ) or performance-based pay ( contingent contract ). The employee then chose an 3 Several theoretical models explored the detrimental effects of the performance contingent wage schemes on performance and gave potential (behavioral) economic explanations (Benabou and Tirole 2006; Ellingsen and Johannesson 2008; Fischer and Huddart 2008; Huck, Kübler and Weibull 2010; Shchetinin 2009). Fehr and Rockenbach 2003, Falk and Kosfeld 2006 or Irlenbusch and Sliwka 2005 provide experimental evidence for such crowding-out effects. 5

7 effort level e [0, 100] at private costs c(e) 1/12 e 2. This effort level determined the probability that the respective principal received a high payoff, i.e. with probability e she earned 12 ( success ) and nothing otherwise. Under the fixed wage contract the employee received an unconditional wage of 5 from the employer. Under the contingent contract the employee received 5 if the outcome was successful and 0 otherwise. We elicited efforts for both contract types using the strategy method such that each agent had to state the effort level chosen under both contract types before learning about the principal s choice. Employees had also access to an on-screen computation tool, where they could insert effort values for a particular contract, and learn the costs of effort and (expected) payoffs of employee and employer. The participants could use this tool for as many trials as they wanted before they decided to determine their final decision. After the decisions were made, the level of effort was realized which corresponded to the principal s actual contract choice. We conducted two treatments in this first experiment: In the baseline treatment the principal chose a contract without any additional information about employees behavior. In the norms treatment each employer learned the effort choices of all agents for both contract types from a previous baseline session (i.e. a table showing the effort levels of 10 employees). For employees nothing was changed relative to the baseline session except for the fact that they were informed that the principals had observed the information on the behavior of participants from the previous session before making the contract choice. At the end of the experiment, subjects were informed about the achieved outcome and their payoffs. Average earnings were Each subject participated only once. The experiment lasted about one hour. 6

8 3. Results The key hypothesis we investigate is that employees should react differently to an identical contract choice if they know that the principal making this choice is better informed about the behavior of other agents in an economically perfectly identical situation. In particular, they should choose a higher effort level under a fixed wage if this contract is proposed by an informed principal. The reason is that the contract choice then should reveal that apparently many other agents in the same situation did not shirk as otherwise the principal would not have proposed this contract. And if social norms matter this should indeed have an impact on the actual effort choices and lead to higher efforts. In each of the two treatments we collected 30 independent observations on the employees effort choices for each of the two contract types. It is important to note that any potential treatment effect on the agent s efforts must be driven by the (on the part of the agents) minor treatment difference that agents in the norms treatment were informed that the principal made his contract choice having information on the behavior of 10 other agents in the same situation. Figure 1 shows the average efforts for both contracts in the baseline and the norms treatment. We are mainly interested in the employees reaction to the trust contract: The average (median) effort in the baseline treatment is 35.4 (30.5), whereas in the norms treatment the employees provide on average (median 60). 4 This difference is statistically significant at the 5% level (p=0.0338, two-sided Mann-Whitney U test). 4 Note that the second-best (i.e. the agent s payoff maximizing) effort level for the contingent contract is 30 and the first-best (i.e. joint payoff maximizing) effort is 72. 7

9 FIGURE 1: AVERAGE EFFORTS FOR TRUST CONTRACT AND CONTINGENT CONTRACT Figure 2 shows the distribution of efforts for both contracts and treatments. With the exception of the very low effort choices close to zero 5, the distribution seems to be shifted to the right. The fact that there is no substantial difference at the lower tail of the distribution is in line with the theoretical prediction, as there should be a fraction of steadfastly selfish individuals, who contribute zero under the fixed wage regardless of any information on the social norm. If the principal offers a trust contract, only 50% of subjects provided an effort above 30 in the baseline treatment, whereas this number increased to 80% in the norms treatment. This difference is significant at the 5% level (p=0.029, two-sided Fisher s exact test). 5 The costs of effort were rounded on two decimal digits. This led to identical zero-costs for effort equal to zero, one or two units. 8

10 Interestingly, 16.67% of the subjects in both treatments contributed exactly 60 under the fixed wage. At an effort level of 60 the principal s expected payoffs are exactly equal to the agent s payoffs. This is again well in line with the idea that there are steadfastly fair agents whose choices are unaffected by information about the behavior of others. FIGURE 2: EFFORT DISTRIBUTIONS Percent Baseline Norms Effort Trust Contract Baseline Norms 0 5 Percent Effort Performance Contingent Contract In contrast to the trust contract, we do not observe any significant difference in employees effort for the contingent contract: Here the average (median) effort is (43.00) in the baseline and (49.50) in the norms treatment (p=0.4322, two-sided MWU test). Again this is well in line with the theory. As also purely self-interested agents here have an incentive to exert positive effort levels the impact of social norms should be substantially smaller. 9

11 We also classified agents by whether they contribute less under the trust contract then under the performance contingent contract. In the baseline treatment 53.33% of subjects exert less effort for the fixed pay than for the contingent pay. However, in the norms treatment this fraction drops to only 26.67% (p=0.064, two-sided Fisher s exact test). We also estimated a number of simple OLS regressions which are reported in Table 1. In model (2) we regress the effort under fixed pay on the treatment dummy. Again we observe that in norms treatments agents provide approximately 17.5 units effort more than employees in the baseline treatment while there is no significant difference under the performance contingent wage as reported in column (2). Norms treatment TABLE 1: REGRESSION ANALYSIS (1) (2) (3) effort under performance contingent pay effort under fixed pay effort (2) effort (1) 17.50** * (7.78) (5.94) (6.55) Constant 52.87*** 48.60*** (5.77) (4.87) (4.70) Observations R 2 / Pseudo-R Notes: Models (1) (3) represent the OLS estimates. Robust standard errors are reported in parenthesis. The reference group is the baseline treatment.. *** Significant at the 1 percent level. ** Significant at the 5 percent level. * Significant at the 10 percent level. In model (3) the dependent variable is the difference between the fixed wage effort and contingent effort on the treatment dummy. The coefficient of the norms treatment dummy is negative and at the 10 % level weakly significant Although the behavior of agents under the trust contract is more favorable in the norms treatment, the trust contract is expensive and still rather risky from a principal s perspective. Indeed, most principals actually chose the incentive 10

12 contract as it is less costly and leads to a more certain outcome. We find that in both treatments only 10% of employers actually offered a trust contract. However, while principals who chose the trust contract in the baseline treatment made losses on average, the trust contract was profitable in the norms treatment. Overall we find substantial support for the key hypothesis that contracts can indeed signal social norms and, in turn affect behavior in an indirect way beyond the direct incentive effects. Moreover, these effects are sizeable and apparently result in a substantially improved performance under non-contingent contracts. Of course it is important to dig deeper into the behavioral mechanisms at work. In the next section we therefore report results from a second experiment in which we investigated to what extent the contract choice affects the beliefs of agents about the behavior of others. 4. Belief Elicitation Experiment A key element of the hypothesized mechanism is that the contract choice indeed affects agents beliefs about the behavior of others. In the first experiment we intentionally refrained from eliciting the agents beliefs about what principals saw in order to reduce potential experimenter demand effects. Therefore we conducted a second experiment with the sole purpose to investigate the conjectured belief effects. This second experiment was conducted online and participants only had to respond to simple questions about their beliefs about the information a principal had when making one of the two contract choices. The participants were then paid according to the precision of their estimate. The 118 subjects who took part received the instructions for the norms treatment of the previous experiment and were informed that this experiment had been carried out before and that their task would be to estimate the behavior of 11

13 subjects in the earlier experiment. In particular, they were asked to state their beliefs about the average efforts that principals had observed before they made a particular contract choice. We conducted two treatments: in the first treatment subjects had to estimate the average efforts observed by a principal randomly chosen among those who then chose a trust contract in the norms treatment of our previous experiment. In the second treatment they had to estimate the average efforts observed by a principal who had chosen a contingent contract. In both new treatments subjects were paid based on the deviation from the average efforts that were indeed observed by this particular principal (recall that these were the efforts chosen for both contract types in one session of the baseline treatment in our first experiment). Hence, subjects had to state two numbers one for the average efforts under the trust contract and one for average efforts under the contingent contract both observed by this particular principal. Note that a comparison of the two new treatments thus allows us to investigate to what extent the actual contract choice of a principal reveals information about this principal s information about the behavior of others prior to the choice. The key hypothesis is that participants who have to estimate the prior information of a principal who actually proposed a fixed wage contract should on average believe that this principal has observed higher efforts that a principal who actually chose a contingent contract. Our design intentionally elicits these beliefs in a between subject design (with regard to the principal s contract choice) again in order to reduce potential experimenter demand effects. Each subject participated only once. The participants were paid online or in cash based on the quadratic scoring rule. For each of the two effort averages subjects received 3 minus 1 cent for each unit of quadratic deviation from the true value. They received nothing if their guess deviated by more than 17 points from the true value. 12

14 TABLE 2: BELIEFS ABOUT AVERAGE EFFORTS OBSERVED BY PRINCIPALS Trust contract effort Contingent contract effort Employer chose trust contract Employer chose contingent contract As reported in Table 2 subjects who had to state their beliefs about efforts observed by a principal who chose a fixed wage contract estimated efforts that are by 26.95% higher than subjects in the other treatment who had to estimate the information observed by a principal who chose the contingent contract (p=0.0006, two-sided MWU test). The distribution of average effort estimations are shown in Figure 3 (two panels in the left column for the treatment were the principal chose the contingent contract and two panels in the right column, where the principal chose the trust contract). 13

15 FIGURE 3: RESULTS OF THE ONLINE EXPERIMENT Percent If principal chose contingent contract If principal chose trust contract Effort Trust Contract If principal chose contingent contract If principal chose trust contract Percent Effort Performance Contingent Contract Consistently, we observe the opposite relation for the estimates about observed efforts under the contingent contract. The participants expected principals to have observed significantly higher efforts here if they actually went on to offer this performance contingent contract (p=0.008, two-sided MWU test). Hence, the contract choice indeed strongly affects the beliefs of others about prior information obtained by this principal. 5. Conclusion Our main conclusion is that contracts can indeed convey information about the behavior of others previously observed by the contract designer. Moreover, this information apparently has a substantial impact on behavior beyond the direct incentives induced by that contract. Individuals react very different to an identical 14

16 contract when they know that the contract choice is based on richer information about prior reactions of others. In particular, this effect is important for contracts that rely to a large extent on the non-selfish behavior of the other party. The reason is that in these cases social norms have a substantially stronger effect on effort choices as compared to contracts that provide incentives also for purely selfish agents and thus come along with a weaker risk of exploitation. When an agent works under a contract which is based on trust and thus leaves substantial degrees of freedom there is more uncertainty on the appropriate behavior. In these cases information about social norms, i.e. the behavior of others has a much stronger effect: When agents learn that principals apparently observed that on average agents can be trusted they shirk significantly less often and reward this trust to a much stronger extend. This result also has important implications for the design of incentive schemes in practice. The results indicate that trust in one s own employees can indeed to some extent be self-fulfilling as it reveals to these employees that large parts of the workforce can be trusted and this, in turn, increases the trustworthiness of many. Of course there many important questions that need to be addressed in future research. First of all, experiments have to be conducted to test the direct link between the agents beliefs about the behavior of others and their own actions. Moreover, it seems important to study the consequences of changes in the incentive structure on social norms in field settings for instance by exploiting information from employee surveys or using lab experiments in firms to elicit social norms before and after a change (see, for instance, Burks and Krupka 2012). Further research on the impact of norms on the one hand and contractual choices that can affect these norms on the other, hence, seems very valuable to advance the understanding of the effects of incentives in practice. 15

17 REFERENCES Bénabou, R., and J. Tirole Incentives and Prosocial Behavior. American Economic Review 96 (5): Bernheim, B. Douglas A Theory of Conformity. Journal of Political Economy, 102(5): Burks, S. V., and E. L. Krupka Behavioral Economic Field Experiments Can Identify Normative Alignments and Misalignments within a Corporate Hierarchy: Evidence from the Financial Services Industry Management Science, 58: Clark, Andrew E Unemployment as a Social Norm: Psychological Evidence from Panel Data. Journal of Labor Economics, 21(2): Ellingsen, R., and M. Johannesson Pride and Prejudice: The Human Side of Incentive Theory. The American Economic Review 98 (3): Elster, J Social Norms and Economic Theory. The Journal of Economic Perspectives 3 (4): Falk, A., and M. Kosfeld The Hidden Costs of Control. The American Economic Review 96 (5): Fehr, E., and B. Rockenbach Detrimental Effects of Sanctions on Human Altruism. Nature 422 (6928): Fehr, E., and U. Fischbacher. 2004a. Third-party Punishment and Social Norms. Evolution and Human Behavior 25 (2): b. Social Norms and Human Cooperation. Trends in Cognitive Sciences 8 (4): Fehr, E., U. Fischbacher, and S. Gächter Strong Reciprocity, Human Cooperation, and the Enforcement of Social Norms. Human Nature 13 (1): Fischer, P., and S. Huddart Optimal Contracting with Endogenous Social 16

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