Radhika Lunawat

The Role of Information in Building Reputation in an Investment/Trust Game

This article analyses the role of information in building reputation in an investment/trust game. The model allows for information asymmetry in a finitely repeated sender–receiver game and solves for sequential equilibrium to show that if there are some trustworthy managers who always disclose their private information and choose to return a fair proportion of the firms income as dividend to the investor, then a rational manager will mimic such behaviour in an attempt to earn a reputation for being trustworthy. The rational manager will mimic with probability 1 in the early periods of the game. The investor, too, will invest with probability 1 in these periods. However, in the later periods, the rational manager will mimic with a certain probability strictly less than 1. The probability will be such that it will make the investor indifferent between investing and not investing, and he, in turn, will invest with a probability (strictly less than 1) that will make the rational manager indifferent between mimicking and not mimicking; that is, the game will begin with pure-strategy play but will switch to mixed-strategy play. There is one exception, though: when the investors ex ante beliefs about the managers trustworthiness are exceptionally high, the game will continue in a pure strategy, and the switch to mixed-strategy play will never occur. Identical results obtain if the managers choice of whether to share his private information with the investor is replaced by exogenously imposed information sharing.

The impact of financial histories on individuals and societies: A replication and extension of Berg et. al.

Abstract We replicate and extend the social history treatment of the Berg, Dickhaut, and McCabe (1995) investment game, to further document how the reporting of financial history influences how laboratory societies organize themselves over time. We replicate Berg et al. (1995) by conducting a No History and a Financial History session to determine whether a report summarizing the financial transactions of a previous experimental session will significantly reduce entropy in the amounts sent by Investors and returned by Stewards in the investment game, as Berg et al. (1995) found. We extend Berg et al. (1995) in two ways. First, we conduct a total of five sessions (one No History and four Financial History sessions). Second, we introduce Shannon’s (1948) measure of entropy from information theory to assess whether the introduction of financial transaction history reduces the amount of dispersion in the amounts invested and returned across generations of players. Results across sessions indicate that entropy declined in both the amounts sent by Investors and the percentage returned by Stewards, but these patterns are weaker and mixed compared to those in the Berg et al. (1995) study. Additional research is needed to test how initial conditions, path dependencies, actors’ strategic reasoning about others’ behavior, multiple sessions, and communication may mediate the impact of financial history. The study’s multiple successive Financial History sessions and entropy measure are new to the investment game literature.

Reputation Effects of Disclosure: An Experimental Investigation

This paper examines experimentally the sequential equilibrium theory of reputation and disclosure developed in Lunawat, 2009. It provides experimental evidence in support of the sequential equilibrium play and of the reputation building role played by disclosure. The said paper predicts higher investment in economies with disclosure as compared to those without. In testing this prediction, this paper introduces a two-stage experimental design which turns out also to be a contribution to experimental methodology. The two-stage design allows for construction of subject samples with uniform prior beliefs about a manager’s trustworthiness but different disclosure institutions. Data collected using this design provides support for the said prediction. This paper also sheds light on a related question of the reputation building role played by incremental disclosure. It introduces a multi-period setting that allows reinvestment of capital and provides for definition of incremental disclosure in an economy. It is shown that incremental disclosure results in even higher investment.

A Peek Behind the Curtain that Conceals Self-Dealing

Because successful self-dealing cannot be observed in naturally occurring data, we conduct an experiment where self-dealing emerges endogenously along with concealment strategies. We show that subjects can profitably self-deal while fashioning complex strategies that include opacity-preserving resource divisions and misleading direct communication that can build false trust in partners that can be later exploited. These strategies also entail profit skimming that has the paradoxical effect of reducing private gains from self-dealing. Ultimately, self-dealing occurs frequently in economies that generate larger social gains from exchange than economies where hard information provision leads to fully transparent resource allocation.