An Experimental Investigation of Moral Hazard in Costly Investments

Frequently, parties make sequential decisions regarding investments for which the probability of success or failure is dependent on the amount of total investment. This paper reports a series of experiments involving a costly investment game that is derived from the catalytic finance model of Morris...

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Bibliographic Details
Published in:Southern economic journal 2008-01, Vol.74 (3), p.725-746
Main Authors: Deck, Cary A., Reyes, Javier
Format: Article
Language:English
Subjects:
Analysis
Business losses
Debt
Debtors
Decision making
Econometrics
Economic behaviour
Economic reform
Economics
Finance
Financial investments
Investment
Investment decisions
Investment strategies
Investments
Investors
Laboratories
Management
Moral hazard
Opportunity costs
Public infrastructure
Return on investment
Risk aversion
Solvents
Success
Third party
Ultimatum game
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Summary:Frequently, parties make sequential decisions regarding investments for which the probability of success or failure is dependent on the amount of total investment. This paper reports a series of experiments involving a costly investment game that is derived from the catalytic finance model of Morris and Shin (Global games: Theory and applications. In "Advances in Economics and Econometrics". "Proceedings of the Eighth World Congress of the Econometric Society", edited by M. Dewatripont, L. Hansen, and S. Turnovsky. Cambridge, MA: Cambridge University Press, pp. 56-114). The sequential nature of investments is such that the second investment could function as a complement to the initial investment or simply serve as a substitute to it, thereby creating moral hazard. The features of this game are similar to those of the ultimatum game. However, there are several key differences between the games that may account for the high frequency of materially self-interested behavior that we observe, particularly among second movers.
ISSN:0038-4038
2325-8012
DOI:10.1002/j.2325-8012.2008.tb00861.x