Download On the Role of Emotions in Economic Decision Making

On the Role of Emotions in Economic Decision Making: An Experimental
Analysis
By Kevin Grubiak
Experimental Economics II
1. Introduction
“If emotions play such an important role in psychological processes, they are also likely to be
relevant for understanding economic decision making.” (Bosman and van Winden 2002:
p.147)
“At higher intensities, [negative emotions] progressively seize command over behavior,
causing people to experience themselves as being ‘out of control’.” (Loewenstein 2000: p.428)
A major drawback of the standard economic approach of modelling economic agents as
selfish profit-maximizers is the neglect of psychological and affective determinants underlying
the process of decision making. In negotiations, people are frequently observed to reject
mutually beneficial agreements, thereby suggesting that their decisions are affected by more
than material rewards (Tripp et al 1995; Ochs and Roth 1989). Negotiations can often be
described as competitive environments in which each party tries to boost their own individual
outcome (Rubin and Brown 1975). The competitive element of bargaining can result in
intense and heated debates over surpluses that often encourages one party to make a “take
it or leave it” ultimatum to the other in the endgame of negotiation (Pillutla and Murnighan
1996). The dynamics of ultimatum bargaining have been the subject of considerable attention
in experimental economics. Contrary to theoretical predictions, positive ultimatum offers are
sometimes rejected, leaving both parties with lower economic outcomes than they would
have achieved if they had agreed.
A general interpretation of this observation is the violation of fairness norms or fairness
perceptions (Fehr and Rockenbach 2004). But when does the violation of fairness perceptions
actually affects behavior? Pilluta and Murnighan (1996: p.221) suggest that emotional
reactions provide the critical link that determines when fairness perceptions tend to affect
immediately subsequent behavior. They identify anger as a compelling short term explanation
for ending negotiations or limiting interaction. In this sense, emotional dynamics can
overwrite rational reasoning and may make bargaining parties even wonder about their own
willingness to suffer unnecessary losses in the first place. Over the last few decades,
economists have started to pay greater attention to the complexity of emotions and
especially on how negative emotions generate behavior (Bosman and van Winden 2002, BenShakhar et al. 2007, Hopfensitz and Reuben 2009, Joffily et al. 2011). The seminal work of
Bosman and van Winden (2002) experimentally investigates people’s willingness to trade off
monetary gain with emotional satisfaction that arises from the opportunity to punish
unpleasant behavior. They find that monetary incentives prevail when the intensity of
perceived negative emotions is low, whereas for high emotional involvement people are
willing to give up all of their endowment to punish selfish behavior. They conclude that
although the “number of agents whose behavior is influenced by emotions is not very large”
and the “degree of emotional hazard is likely to represent a lower bound”, the impact of
emotions can be quite substantial because subjects make rather ‘extreme choices’ (Bosman
and van Winden 2002: p. 164).
The purpose of this study is to investigate whether the low frequency of punishments in the
initial study by Bosman and van Winden can be attributed to their specific experimental
design. The remainder of this paper is structured as follows: chapter 2 clarifies the structure
of the power-to-take game, elaborates the rationale behind modifying the initial design and
derives the research hypotheses. Chapter 3 deals with the experimental design of this study.
Chapter 4 analyzes the gathered data and discusses the results. Chapter 5 concludes.
2. Framework and research hypotheses
2.1 The power-to-take game
The study at hand utilizes a modified version of the power-to-take game (henceforth PTTG)
to analyze the link between emotions and economic behavior. In the general version of the
game (Bosman and van Winden, 2002), participants are endowed with an initial amount of
money (𝑌𝑖 ) and are randomly and anonymously assigned to either the role of the ‘takeauthority’ or the role of the ‘responder’. In the first stage, the take-authority is permitted to
declare a continuous fraction t ∈ [0,1] of the responder’s endowment to be transferred to the
take-authority. In the second stage, responders are informed about the declared take rate
and are permitted to declare a continuous fraction d ∈ [0,1] of their own prior-to-the-take
endowment to be destroyed. Therefore, the payoffs of the game are (1-t)(1-d)𝑌𝑟𝑒𝑠𝑝 for the
responder and 𝑌𝑡𝑎𝑘𝑒 +t(1-d)𝑌𝑟𝑒𝑠𝑝 for the take-authority.
Since the responder can only destroy own income, punishment is costly. If subjects are
rational profit-maximizing agents, standard economic theory predicts that the responder
should not destroy any endowment if the take rate is less than 1 and should be indifferent
between all possible destruction rates if the take rate is 1. Hence, from backward induction,
the take-authority should select t = 1 – 𝜀, where 𝜀 is an infinitesimal positive number.
If responders are motivated by fairness considerations, however, it can be expected that any
declared take rate will be perceived as an unfair claim which might be associated with
emotions such as anger and contempt. Whether or not a violation of perceived fairness
actually results in costly punishment is expected to depend on the intensity of perceived
emotions.
The PTTG had been applied to different scenarios in which a) people were simply provided
with initial endowments like manna from heaven (Bosman, Sutter and van Winden 2000), b)
initial endowments were determined based on a real effort task prior to the game (Bosman
and van Winden 2002) and c) decisions were determined by groups instead of individuals
(Bosman, Henning-Schmidt and van Winden 2000).
All of these experiments share the common feature that subjects were endowed with roughly
the same initial income. Even in those experiments in which initial endowments were
determined by a real effort task, this task was set up by the experimenters such that almost
all subjects earned an equally sized endowment (Bosman and van Winden 2002: p. 151). It
can be shown, however, that the feature of symmetric initial endowments has an impact on
the severity of punishments in terms of final earnings. Relative earnings of the game are given
by
𝑃𝑡𝑎𝑘𝑒
𝑃𝑟𝑒𝑠𝑝
=
𝑌𝑡𝑎𝑘𝑒 +𝑡(1−𝑑)𝑌𝑟𝑒𝑠𝑝
(1−𝑡)(1−𝑑)𝑌𝑟𝑒𝑠𝑝
. The initial endowment of the take-authority (𝑌𝑡𝑎𝑘𝑒 ) enters the
numerator of this equation as an additive constant. The only endowment at stake is therefore
the endowment of the responder. The responder can decide to destroy part of his or her own
endowment in order to reduce only the additional earnings of the take-authority arising from
the decision on the take-rate. Since punishment is costly for the responder, it is reasonable
to assume that the punishment decision is related to the ‘fine-to-fee’ ratio, defined as “the
income reduction for the targeted subject relative to the cost for the subject who requested
the punishment” (Casari 2005: p.107).1 The study at hand, however, claims that responders
might value the severity of punishment not only depending on the cost at which they can
reduce additional payoffs of the take-authority, but also take aggregate final earnings into
account.
For the purpose of illustration, suppose both participants are initially endowed with 15 ECU.
The take-authority claims 60% (9 ECU) of the responder’s endowment. If the responder values
the severity of punishment according to the cost at which he can reduce the take-authority’s
additional payoffs, a destruction rate of 100% would correspond to a reduction of the takeauthority’s additional payoffs by the equivalent of 100%. However, if the responder is
concerned about aggregate final earnings, he takes into account 𝑌𝑡𝑎𝑘𝑒 even though this
fraction of the take-authority’s earnings is not at stake. In this situation, the relative low
9
punishment severity of (24=) 37.5% might refrain people from destruction.
In order to eliminate this possible confound, the present study utilizes a PTTG with
endowment asymmetries in which only the responder is endowed with an initial income.
Since the responder is now able to destroy overall endowments, this modification increases
the effectiveness of punishment on aggregate final earnings. Whereas in the original PTTG
the take-authority always ends up with at least 𝑌𝑡𝑎𝑘𝑒 , defection of the responder under the
present design results in both parties earning nothing. This element of the experimental
design also seems to be a reasonable approximation of real-world bargaining situations in
which individual benefits can only be realized if agreements are reached.
2.2 Research hypotheses
Galeotti (2013: p. 3) shows that the general PTTG exhibits a variable ‘fine-to-fee’ ratio, i.e. for higher
take rates the responder has a higher incentive to punish because punishment becomes cheaper. He
finds that the original PTTG results are robust even under a constant ‘fine-to-fee’ ratio.
1
Within the framework of emotion theory, emotions are assumed to imply action tendencies.
Whether or not these tendencies result in real actions depend on a ‘regulation phase’ in which
consequences are cognitively evaluated by the subject. Very strong emotions are assumed to
be able to s-urpass so-called ‘regulation thresholds’, thereby seizing command over behavior
(Frijda 1986; Lazarus 1991). In line with emotion theory, Bosman and van Winden (2002) find
that subjects typically destroy nothing or everything and that this decision is significantly
related to the perceived intensities of contempt and irritation about the behavior of the takeauthority.
The objective of the present study is to check for the robustness of the aforementioned
results in a modified PTTG design as outlined before. We expect economic decisions to be
related to the intensity of perceived emotions. Since our PTTG design exhibits a higher
punishment severity, we hypothesize that subjects will become more likely to engage in costly
punishment and might also make use of intermediate destruction rates more frequently.
This result would call into question the earlier conclusion by Bosman and van Winden (2000:
p. 164) that the “number of agents whose behavior is influenced by emotions is not very
large” and the “degree of emotional hazard is likely to represent a lower bound”.
3. Experimental design
The experiment was conducted on the 28th and 30th of April in pen and paper format at the
University of East Anglia. In total, 40 subjects participated in the experiment over 4 sessions.
Subjects were recruited on a voluntary basis via university email. Each session lasted
approximately 40 minutes and no subject was allowed to participate in more than one
session. Average earnings were 3.5£, with a minimum of 2£ and a maximum of 6£.
Before the experiment started, each desk was assigned either an A or a B. Therefore, by
randomly drawing the number of the desk from a bag upon arrival, subjects were randomly
and anonymously assigned to either the role of participant A (take-authority) or participant B
(responder). The instructions were read aloud by the experimenter, followed by a short
multiple choice questionnaire to check understanding.2 Only very few subjects struggled with
the questionnaire. Clarifications had been given publicly to secure anonymity.
Each participant A was randomly and anonymously matched with a participant B according to
the drawn desk number. Who was matched with whom was only known by the experimenter.
All participants A were initially endowed with 0 Experimental Currency Units (ECU), whereas
all participants B were initially endowed with 40 ECU. This information was common
knowledge. Participants A were provided with a form on which they were asked to indicate
the take rate, that is the proportion of participant B’s endowment that would be transferred
to participant A at the end of the experiment. Subsequently, forms were collected and
redistributed to the paired participants B who were asked to indicate the destruction rate,
which is the proportion of their initial endowment that will be destroyed. The forms were
then redistributed back to the participants A, who could take note of the decision of their
paired counterpart. While forms were collected to determine final earnings, subjects were
asked to fill in a questionnaire concerning emotions and personal information. As in Bosman
and van Winden (2002), subjects were presented with a list of eleven emotions. They were
asked to indicate how much they felt the emotion on a 7-point Likert scale when they learned
the decision of their counterpart. At the end of the experiment, subjects remained seated
until they were individually asked by the experimenter to collect their final earnings. In this
way, anonymity was secured with regard to who earned what.
4. Results
Individual data on take and destruction rates is presented in table 1. As can be observed from
this table, take rates range from 50 up to 100% (with a mean take rate of 67.55%). A take rate
of 50% that corresponds to an equal share of endowments never got punished by the
responder. However, as soon as the take-authority claimed more than the equitable amount,
the responder`s willingness to destroy endowment increased progressively.
2
Experimental materials are provided in Appendix B.
Table 1: Summary of individual data
Case no.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
𝑌𝑡𝑎𝑘𝑒
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
𝑌𝑟𝑒𝑠𝑝
t (%)
50
50
50
50
50
50
55
55
55
60
60
60
66
75
80
90
90
95
100
100
40
40
40
40
40
40
40
40
40
40
40
40
40
40
40
40
40
40
40
40
d (%)
0
0
0
0
0
0
10
30
0
70
100
0
50
0
20
100
100
100
100
100
Note: 𝑌𝑡𝑎𝑘𝑒 /𝑌𝑟𝑒𝑠𝑝 denote initial endowments in Experimental Currency Units. Each
participant’s final amount of ECU’s was exchanged at the end of the experiment according to
the following exchange rate: 1 ECU = 10 pence.
In order to investigate the role of emotions on economic decision-making, we first run
ordered logit regressions to assess the influence of the take rate on the intensity of perceived
emotions of the responder. The results are given in Table 2 and suggest that higher take rates
are statistically significantly related to higher intensities of perceived anger, contempt and
irritation and lower intensities of perceived happiness and joy.
Table 2: Ordered logit regressions of emotions on take rate
Dependent variable
Explanatory variable
Coefficient
Std. Error
Anger
Take rate
0.150 ***
0.047
Contempt
Take rate
0.087 ***
0.029
Happiness
Take rate
-0.056 **
0.024
Joy
Take rate
-0.071 ***
0.027
Irritation
Take rate
0.087
0.031
Surprise
Take rate
-0.015
0.021
Envy
Take rate
-0.013
0.023
Shame
Take rate
-0.055
0.035
Sadness
Take rate
-0.001
0.024
Fear
Take rate
-0.075
0.089
Jealousy
Take rate
0.022
0.025
Note: n=20; **p < 0.05; ***p < 0.01.
To assess the influence of the intensity of perceived emotions on the decision of the
responder whether or not to destroy endowment, Table 3 provides the results of binary logit
regressions. The dependent variable takes the value 1 if a responder destroyed income and 0
if she did not.3 We observe that those emotions which were found to be triggered by the take
rate subsequently influenced the responder’s decision on the destruction rate. Higher
intensities of perceived anger and contempt increase the likelihood of the responder to
destroy endowment, whereas higher intensities of joy and happiness decrease the likelihood
to destroy endowment.
Further support for this finding is given by a Mann-Whitney comparison of means across the
groups of subjects who destroyed endowment and those who did not. It turns out that 𝐻𝑜 of
no significant difference of perceived emotions across groups can be rejected for anger,
contempt, happiness, joy (all p < 0.01) and irritation (p < 0.1). With regard to the other
emotions differences in perceived emotions show no statistically significant effect on
behavior.
Table 3: Binary probit regressions of destruction on emotions
3
Dependent variable
Explanatory variable
Coefficient
Constant
Destroy (Yes/No)
Anger
0.750 ***
(0.244)
-1.956 ***
(0.724)
Destroy (Yes/No)
Contempt
1.144 ***
(0.394)
-2.948 **
(1.195)
Destroy (Yes/No)
Happiness
-0.908 ***
2.494 ***
We could have estimated a Tobit model to keep additional information on intermediate destruction rates.
However, given the very small sample size of this study and the drawback of high censoring in the Tobit model,
we opted for a probit model.
(0.324)
(0.843)
Destroy (Yes/No)
Joy
-0.948 ***
(0.353)
2.496 ***
(0.876)
Destroy (Yes/No)
Irritation
0.306 *
(0.161)
-0.698
(0.512)
Destroy (Yes/No)
Surprise
-0.074
(0.152)
0.422
(0.672)
Destroy (Yes/No)
Envy
0.193
(0.246)
-0.259
(0.566)
Destroy (Yes/No)
Shame
-0.023
(0.239)
0.166
(0.505)
Destroy (Yes/No)
Sadness
0.224
(0.325)
-0.223
(0.580)
Destroy (Yes/No)
Fear
0
(omitted)
0.282
(0.300)
Destroy (Yes/No)
Jealousy
0.273
(0.291)
-0.323
(0.546)
Note: n=20; *p < 0.1; **p < 0.05; ***p < 0.01; standard errors in parentheses.
The aforementioned results reproduced the critical link between emotions and decisionmaking found in previous studies. However, Bosman and van Winden (2002: p. 156) also
found that behavior of the responder is related to expectations about the behavior of the
take-authority and whether or not these expectations are violated. A drawback of their
approach might be that they elicited expectations towards the end of the experiment,
therefore after participants had already learned about actual take and destruction rates. The
authors note that “it is possible that responders who were too optimistic found it hard to
admit that they were wrong” (p. 156).4 To avoid the possibility of systematic bias in reported
expectations, subjects in the present study were asked to fill their expectations in the
questionnaire before actual decision had been revealed. It, however, turns out that our data
cannot confirm a significant influence of expectations on the decision of the responder to
destroy endowment.
4
The authors defend their approach by showing that the correlation between the take rate and the expected
take rate is low and insignificant. They conclude that there is no systematic bias in responders’ reported
expectations of the take rate.
Regarding our research hypothesis, we assumed that subjects would become more likely to
engage in costly punishment and might also use costly punishment more frequently. With
reference to the summary statistics in Appendix A, we find that eleven (55%) out of 20
responders decided to destroy at least some fraction of their endowment. In previous studies,
this fraction was found to be significantly lower, namely 20.5% (p < 0.01) under a real effort
task treatment and 37.5% (p < 0.1) under a no-effort task treatment (Bosman, Sutter and van
Winden 2000: p.8). The higher willingness of responders to destroy endowment in the present
study is in line with the research hypothesis that subjects become more likely to engage in
costly punishment when punishment is more severe. Moreover, we observe that a good
portion (45%) of all destructions were of intermediate magnitude. Destruction rates
progressively increase in magnitude as soon as the take-authority claims a higher share of the
overall money at stake.
A possible explanation is the violation of fairness considerations. Interestingly, subjects in the
present study seem to be more sensitive to violations of fairness norms than they were
observed to be in previous studies of the PTTG. In the present study, we observe that subjects
already engage in costly punishment when take rates deviate only slightly (e.g. t = 55%) from
the fairness threshold of t = 50%. Recall that under a design with symmetric initial
endowments, “one may expect zero take rates from a fairness point of view” (Bosman,
Henning-Schmidt and van Winden 2000: p. 10). In these studies, however, subjects were
found to destroy endowments only for very high deviations (t > 70%) from the fairness
threshold of t = 0%. We suggest that this observation might be attributed to our modification
of the PTTG design in which punishment is more effective in terms of final earnings. For any
given take rate, a destruction rate of 100% eliminates any differences in final earnings among
the responder and the take-authority, whereas under the symmetric design we observe a
wedge between final earnings since the take-authority always ends up with at least 𝑌𝑡𝑎𝑘𝑒 .
Fehr and Schmidt (1999) point out that a fraction of people motivated by fairness also exhibit
a desire to arrive at equal outcomes (inequity aversion). Subjects in previous studies might
had been less motivated by fairness considerations since they were less capable of reducing
differences in final earnings.
5. Conclusions
Earlier studies have found that although the impact of emotions on behavior can be quite
substantial because subjects make rather ‘extreme choices’, the number of agents whose
behavior is affected by emotions is not very large. The purpose of this study was to check the
robustness of these results against a possible confound inherent in the general design of the
PTTG. That is, responders might have refrained from punishment simply because the severity
of punishments on final earnings was too weak. This is due to the fact that, in the original
design, the take-authority is endowed with an initial income that is not at stake in the game.
This endowment, however, drives a wedge between the final earnings of the take-authority
and the responder, irrespective of whether or not the responder decides to destroy own
endowment.
We applied a PTTG design in which we dropped the initial endowment of the take-authority.
Since this endowment had never been at stake, one could assume that this modification
should not alter the results. In line with our research hypothesis, we however find that
subjects destroy more frequently in our study. Moreover, subjects appear to react more
sensitive to violations of fairness norms and are willing to take costs in order to punish even
minor deviations from the norm.
The results of this study, however, should be considered with caution. As a pilot project, this
experiment suffers certain limitations which restrict the validity of its results. Statistical
inferences suffer from the very small sample size. Also, experiments which aim to assess the
robustness of results found in earlier studies need to replicate the experimental environment
of the original study as close as possible to avoid confounding. Although we tried to ensure
comparability with previous literature on the PTTG by applying very similar experimental
procedures, we for example did not apply a double blind procedure for the payments and
were restricted to pay participants significantly less. Moreover, the statistical analysis could
have been improved by directly conducting an additional treatment to compare the PTTG
results under the symmetric and asymmetric initial endowment design. This, however, would
have required a significantly higher number of observations. Nevertheless, the present study
revealed some interesting findings which might be worth to be examined more precisely
under appropriate experimental conditions in the future.
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