Richard J. Zeckhauser

Status Quo Bias in Decision Making

Most real decisions, unlike those of economics texts, have a status quo alternative—that is, doing nothing or maintaining ones current or previous decision. A series of decision-making experiments shows that individuals disproportionately stick with the status quo. Data on the selections of health plans and retirement programs by faculty members reveal that the status quo bias is substantial in important real decisions. Economics, psychology, and decision theory provide possible explanations for this bias. Applications are discussed ranging from marketing techniques, to industrial organization, to the advance of science.

Reputation systems

Systems T he Internet offers vast new opportunities to interact with total strangers. These interactions can be fun, informative, even profitable. But they also involve risk. Is the advice of a self-proclaimed expert at expertcentral.com reliable? Will an unknown dotcom site or eBay seller ship items promptly with appropriate packaging? Will the product be the same one described online? Prior to the Internet, such questions were answered, in part, through personal and corporate reputations. Vendors provided references, Better Business Bureaus tallied complaints, and past personal experience and person-to-person gossip told you on whom you could rely and on whom you could not. Participants’ standing in their communities, including their roles in church and civic organizations, served as a valuable hostage. Internet services operate on a vastly larger scale

Earnings Management to Exceed Thresholds

Investors are keenly interested in financial reports of earnings because earnings provide important information for investment decisions. Thus, executives who are monitored by investors and directors face strong incentives to manage earnings. We introduce consideration of behavioural/institutional thresholds for earnings in this mix of incentives and governance. A model illustrates how thresholds induce specific types of earnings management. Empirical explorations find clear support for earnings management to exceed each of the three thresholds that we consider: positive profits, sustain-recent-performance, and meet-market-expectations. The thresholds are hierarchically ranked. The future performance of firms that possibly boost earnings to just cross a threshold appears to be poorer than that of less suspect control groups.

Trust among strangers in internet transactions: Empirical analysis of eBay' s reputation system

One of the earliest and best known Internet reputation systems is run by eBay, which gathers comments from buyers and sellers about each other after each transaction. Examination of a large data set from 1999 reveals several interesting features. First, despite incentives to free ride, feedback was provided more than half the time. Second, well beyond reasonable expectation, it was almost always positive. Third, reputation profiles were predictive of future performance, though eBays net feedback statistic is far from the best predictor available. Fourth, there was a high correlation between buyer and seller feedback, suggesting that the players reciprocate and retaliate.

The Value of Reputation on eBay: A Controlled Experiment

We conducted the first randomized controlled field experiment of an Internet reputation mechanism. A high-reputation, established eBay dealer sold matched pairs of lots—batches of vintage postcards—under his regular identity and under new seller identities (also operated by him). As predicted, the established identity fared better. The difference in buyers’ willingness-to-pay was 8.1% of the selling price. A subsidiary experiment followed the same format, but compared sales by relatively new sellers with and without negative feedback. Surprisingly, one or two negative feedbacks for our new sellers did not affect buyers’ willingness-to-pay. Copyright Economic Science Association 2006

Insurance, Information, and Individual Action

Publisher Summary This chapter discusses some intricacies and difficulties that arise in the real world operation of contingent claims markets. Insurance contracts are the most readily observable and perhaps the most important example of contingent claims markets in action. The purpose of insurance is to protect risk-averse individuals from suffering the full consequences of those actions on the part of nature that affect them unfavorably. Individuals have different incomes in different states of nature and may face different prices. Perfect insurance transfers income between states of nature, preserving marginal cost pricing when the income is spent. With an imperfect measurement of the states of nature, income transfers are conditional on what is observed rather than on the state of nature. Alternatively, one could alter prices to provide insurance.

Estimating the Returns to Insider Trading: A Performance-Evaluation Perspective

This paper uses performance-evaluation methodology to estimate the returns earned by insiders when they trade their companys stock. Our methods are designed to estimate the returns earned by insiders themselves and thereby differ from the previous insider-trading literature, which focuses on the informativeness of insider trades for other investors. We find that insider purchases earn abnormal returns of more than 6% per year, and insider sales do not earn significant abnormal returns. We compute that the expected costs of insider trading to noninsiders are about 10 cents for a

Economic Contests: Comparative Reward Schemes

10,000 transaction.

The optimal control of pollution

Contests are situations in which an individuals reward depends on his performance relative to others. Students are graded on a curve; the candidate with the most votes gets the political office; the underling who performs best is promoted to the executive position. Contests are useful in dealing with indivisible rewards, reducing monitoring costs, and minimizing risks from common uncertainties. They are employed to sort potential participants and, once they have entered, to induce appropriate effort from them. With monitoring precision and prize spreads as potential choice variables, optimal contest structures are derived for fair and unfair contests among equal and unequal participants. The converse problems of climbing-low-ability individuals enter the contest designed for high-ability candidates-and slumming are shown to be manageable.

Eliciting Informative Feedback: The Peer-Prediction Method

Pollution we define to be any stock or flow of physical substances which impairs man’s capacity to enjoy life. So defined, pollution is a pervasive phenomenon. Physical garbage, air and water pollution, soil exhaustion via excessive use, D.D.T., radiation, and the running down of any natural resource faster than it can rejuvenate itself (if it can rejuvenate itself), are all problems of pollution in this extended sense. By operating at such an all-inclusive level we may miss some of the interesting aspects of particular pollutants. We hope to gain in return by illuminating the conceptual similarities among apparently diverse problems. From the time of Professor Pigou, economists have regarded pollution as a problem of externalities. It is not our purpose to suggest that his view of the problem is in error. On the other hand, it is increasingly evident that the traditional remedies proposed for simple cases of market failure may be inadequate to achieve desirable outcomes where matters of pollution are involved. Efforts to deal with these complex and intractable matters may require some form of centralized coordination and control. An approach beyond the usual externalities analysis seems called for. The framework of control theory provides us with insights on the use of mechanisms to direct patterns of consumption and production. The optimal control of pollution may require curtailing certain types of consumption, limiting the use of some productive processes and perhaps even restricting the growth of population. There are strong intertemporal aspects of the pollution problem. They reinforce the relevance of the dynamic approach of control theory. Before proceeding to a formal model, we shall mention three important distinctions that relate to the economic effects of pollutants. The first is whether the pollutant has its major impact on consumption, on production,