Professional Documents
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Abstract
In a credence good market the consumers cannot determine the quality of goods both
before and after the purchase . Examples of credence good are any expert service (like
the medical, legal and financial services) or a car repair service where the same provider
acts as the expert who diagnosis the needs of the client. As consumers cannot ever
observe quality the suppliers in a credence market have the incentives to cheat
consumers and save in effort by delivering a low quality good or service.
The SRO main objective is to create confidence among consumers about quality, hence
consumers expect that an SRO: a) effectively control the quality provided by her
members; and b) punish and publicly expose any big evidence of bad quality service, as
a credible signal of her level of surveillance and the quality the consumers may expect
from the suppliers.
A possible source of incentives could be the potential benefits that a reputation of good
quality provision creates for the SRO: consumers may reward the confidence of good
quality provision with a higher or more stable demand or a higher willingness to pay for
the good (in opposition to a lemon market outcome). Because consumers don’t observe
the effective level of surveillance exerted by the SRO either, they must heavily rely on
the exposure of bad quality services to infer both the existent level of vigilance and the
quality provided by the SRO members.
Though consumers may interpret in two different ways any exposure of fraud which
impacts the incentives of the SRO to make surveillance and expose fraud in different
ways. When consumers cannot observe the effective level vigilance and fraud of an
SRO two scenarios are possible:
1. In the first scenario the consumers interpret any exposure as a signal of a high level
of vigilance that induces the provision of good quality; fraud is found just by
chance. In this scenario the SRO will have a reputational incentive to watch their
members and expose any evidence of fraud.
2. In the second scenario the consumers interpret any exposure as a signal of a low
level of effective vigilance that induces the massive provision of bad quality; it is
not rare to find fraud. In this scenario the SRO will not have a reputational
incentive to make surveillance and expose fraud.
4
The Switzerland Bank Association for example.
5
The General Medicine Council (United Kingdom). The National Council for self regulated Publicity
(Chile).
1
Technically it is not possible to determine which scenario is more plausible because in
the underlying signalling game it is not possible to apply any existing refinement (like
the Cho and Kreps (1989) intuitive criterion) or learning model given the severely
limited ability of consumers to observe vigilance and fraud.
On the other hand, because the evidence of fraud is difficult to establish once it has
happened any field study of the reputational incentives to make vigilance and exposure
is severely limited. This is because the econometrician will share the same uncertainty
that consumers have when she tries to interpret any exposure of fraud.
The main objective of this work is to analyse in the lab how consumers interpret or
learn to interpret the exposure that receive from an SRO, and given this interpretation if
the SRO behaviour is consistent with the presence or absence of a reputational incentive
to make surveillance and expose fraud.
This paper is organized as follows: in section two we introduce the theoretical model
and control variables used in the laboratory, in section three we will discuss the
experimental design, in section four we present the main findings of the experimental
sessions and section five discusses the main implications of our findings.
2
2. The Theoretical Model and Experimental Treatments
The model we use as reference to study the reputational incentives of a SRO is based on
Nuñez (2000) model of Self Regulation under asymmetric information about the SRO
cost of vigilance in credence good markets.
Nuñez described a two-stage game with SRO members, acting as the “agents”,
benefiting linearly from “fraud” but facing a fixed levy if the SRO head, acting as the
“principal”, discovers their fraud using a costly vigilance mechanism. Nature
determines how costly the mechanism of vigilance is and it could be Low or High. A
Low cost principal is expected to make a higher level of vigilance than a High cost
principal under similar situations. Agents are expected to reduce their optimal level of
fraud in reaction to an increase in the expected level of vigilance.
The public’s well being is hurt by fraud thus their perceptions over the principal’s cost
type and its associated level of fraud will affect their market behavior (increasing or
decreasing their demand or their willingness to pay for example); this behavior strongly
determines how valuable is for the principal to be perceived by consumers as a Low or a
High cost type. The principal will benefit from the “reputational gain” of being
perceived as a Low cost type which is the difference between the values for both types.
At the beginning of the game Nature determines the cost type of the principal according
to predetermined probabilities that are common knowledge. The Principal observes her
type and decides an optimal level of vigilance expecting an optimal reaction from the
agent. The agent doesn’t observe the principal’s type and decides an optimal level of
fraud.6 Fraud (x) and Vigilance (y) are exerted and fraud is found (and punished) with
probability P(x,y). If fraud is found the principal takes her second decision: to expose it
or not to consumers. Consumers can’t observe or determine by themselves the
existence of fraud because of the credence characteristic of the market but they observe
if the principal exposes or doesn’t expose any evidence of fraud. With this information
consumers update their beliefs over the principal’s type and level of fraud using the
Bayes rule. Only if consumers’ updated beliefs favor a Low cost type the principal may
receive a reputational gain.
Nuñez showed the existence of Bayesian pooling equilibriums with no exposure, zero
vigilance and maximum level of fraud in this game. A Bayesian pooling equilibrium
with fraud exposure, positive level of vigilance and lower levels of fraud can only exist
when P(x(y*),y*) increases with vigilance. The intuition of the later is that when both
types decide to expose in equilibrium consumers can confidently update their beliefs in
favor of the Low cost type when exposure actually happens and in favor of the High
cost type when it doesn’t.
Because the reputational gain is symmetric for both types we cannot make payoff
comparisons and apply any refinement for signaling games leaving the model with
several equilibriums that we have to discriminate in other way.
For our experiment we simplify the game even further, collapsing the two-stage game
into a single stage game imposing the first-stage outcomes. This simplification allows
6
A Stackelberg game, with sequential decisions, and a Cournot game, with simultaneous decisions,
were modeled. The properties of the equilibria were the same in both situations.
3
the focus in the stage of the game where the very incentives to expose and make
vigilance are determined and facilitates the experimental control and data interpretation;
this also allows the consideration of consumers as a general “Public” whose “opinion”
is our main interest, abstracting from the effects of fraud on consumers’ well being
(which may require an active purchase in the market) and permits the inclusion of both
potential and active consumers of the SRO in the analysis.
Fixing the first stage of the game leaves two types of SRO: a “High vigilance – Low
fraud” or H type, and a “Low vigilance – High fraud” or L type. The predetermined
probability of an H type equals 0.5. Each type finds fraud with probability P(xH*,yH*)
= PH and P(xL*,yL*) = PL respectively.
Because the baseline model predicts the existence of an equilibrium with exposure,
vigilance and low fraud only if P(x*,y*) increases with vigilance, we define the sign of
PH - PL as the first logical control variable for the experiment. Table 1 summarizes the
values of PH and PL used for this control.
PH – PL PH PL
>0 0.8 0.2
<0 0.2 0.8
The reduced game used in the experiment is structured as follows: PH and PL are
common knowledge; at the beginning of the game the SRO learns her type, exerts
vigilance and finds fraud with probability Pi, i = H or L; if fraud is found she decides to
expose it or not to the Public (if fraud is not found the SRO doesn’t expose anything,
i.e., she cannot invent fraud).
The public don’t observe the SRO type; they only observe any fraud exposure. If fraud
is exposed the public update their beliefs of a SRO type H using the Bayes rule:
0.5 ( PH e H )
P ( H / 1) ≡ P ( H / exp osure ) =
0.5 ( PH e H ) + 0.5 ( PL e L )
where ei ∈ { 0 , 1 }, i = H, L , is the decision for each type of SRO to expose fraud (ei
=1) or not (ei =0). If fraud is not exposed the Public update their beliefs using: 7
0.5 (1 − PH eH )
P ( H / 0) ≡ P ( H / no exp osure) =
0.5 (1 − PH eH ) + 0.5(1 − PL eL )
With these new beliefs the Public choose between three possible opinions about the
SRO: a) “She is H”, b) “She is L”, c) “We are uncertain”.
7
Of course, P(L/1) = 1 – P(H/1) and P(L/0) = 1 – P(H/0).
4
The payoffs for the Public were set to give them incentives to build an opinion: If their
opinion coincides with the real type of the SRO they win U > 0, if it doesn’t they win
zero, if they are “uncertain” they win a lottery that gives U or zero with probability 0.5.
The intuition behind this payoff structure is that if fraud really hurts the Public’s well
being they will certainly benefit from building a correct idea over the SRO level of
vigilance and fraud which will be useful when they have to decide to buy or not in the
market. The lottery permits an escape for opinions made at random.
The SRO wins a reputational gain of W > 0 if the public say “It is H”, wins zero (no
reputational gain) if they say “It is L”, if the public are uncertain the SRO wins a lottery
that gives W or zero with probability 0.5. Table 2 summarizes the Payoff structure.
PUBLIC Payoff
If opinion matches the SRO type U
If opinion doesn’t match the SRO type 0
If uncertain (lottery) 0.5 U
SRO Payoff
If public’s opinion is “She is H” W
If public’s opinion is “She is L” 0
If they are “Uncertain” (lottery) 0.5 W
A final assumption with no effect over the predicted Bayesian equilibriums but that is
relevant for experimental sessions with many rounds of the same game, is that the
public will not check if their opinion was right o wrong at the end of the game because
of the credence characteristic of the market (both fraud and vigilance cannot be
observed or verified by consumers thus they cannot observe the SRO type). This
implies that they will not be able to observe how much they earned at the end of the
game.
In the reduced model there are many Bayesians pooling equilibriums in pure strategies
with no exposure under both PH - PL > 0 and < 0. Figure 1 summarizes all of the no
exposure equilibriums of the game assuming w.l.o.g. a payoff of U = W = 100.
With no exposure in equilibrium (eH = eL = 0), P(H/0) equals the predetermined 0.5
because the Public can’t discriminate between a situation of no fraud detection and
another of cover up making them indifferent between opinions. The Bayes rule cannot
be applied to obtain the out of equilibrium beliefs (OEBs) leaving them completely
unconstrained.
For example in Figure (1a) the OEB that sustain the public’s reaction is that an (out of
equilibrium) exposure must come from a SRO type H with probability greater than 0.5.
In Figure (1b) the OEB is that an (out of equilibrium) exposure must come from a SRO
type L with probability greater than 0.5, and in Figure (1c) is that it is equally likely to
come from both types.
5
(a) (b)
(c)
6
(d) (e)
(f)
7
Because the OEBs are unconstrained all of these no exposure equilibriums are
sequential in the sense of Kreps and Wilson (1982). It can also be checked that no
equilibrium refinement can be applied because both the public and SRO doesn’t have
dominated strategies and it is not possible to make any payoff comparison for both
types of SRO (both gain the same maximum of W and minimum of zero so the Cho and
Kreps (1987) intuitive criteria cannot be applied for example).
Even though none of these equilibriums can be refined some of them are not consistent
with what we define as a “BAD interpretation” of fraud exposure. A BAD
interpretation of exposure arises when the public think that exposure is more likely to
come from a SRO type L. The intuition behind this BAD interpretation is that the level
of fraud for a type L must be so high or widespread that any positive level of vigilance
is good enough to find it, and that for an H type the level of fraud must be so low that it
is really hard to find it. If the public has this BAD interpretation of exposure in their
minds they will respond to any exposure with an “L” opinion, and both types of SRO
will not have incentives to expose as a consequence. The only equilibriums in Figure 1
that are consistent with a BAD interpretation of exposure are those in 1(b), 1(d) and 1(e)
(equilibrium in 1(b) Pareto dominates the other two).
BAD GOOD
Players’ actions Interpretation Interpretation
proportions proportions
b) Which kind of interpretation, if any, is supported for the case of PH - PL > 0 where
both BAD and GOOD interpretations are possible.
This is particularly important for our experiment because of the inability of the public to
learn from their correct and wrong opinions (and ex post payoffs) in a credence market
and because most of the literature of learning in games relies on history dependent
adjustment processes where all players can observe the realized outcome of each
strategy they play and completely or partially adjust their beliefs using this information
9
favoring those strategies with higher expected payoffs [Fudenberg and Levine]. Hence,
controlling the available information of PH and PL permits the analysis of human
subjects’ capabilities to learn the underlying structural probabilities and to adjust their
behavior even if they cannot observe their right or wrong actions as public, checking the
robustness of the theoretical predictions and expanding the existent learning
possibilities frontier.
Hence, as our second control variable we include the level of the information of PH and
PL available to players. We establish a FULL information level, where the underlying
structural PH and PL are revealed and remembered to all players to ensure their mutual
knowledge; and also a NONE information level, where no kind of information on these
probabilities is explicitly given but exists in the underlying structure of the experimental
session. The behavior under the FULL information level will serve as a ceiling for what
can (probably) be expected as a long run or steady state in beliefs situation under the
NONE information level if any behavioral adjustment occurs due to the experience and
learning of the structural probabilities and also offers the best environment to test for
the effects of the sign of PH – PL.
The combination of the first and second controls defines four possible treatments for the
experiment, as can be seen in Table 4. Finally, according to Cooper and Kagel [7] the
use of a meaningful context instead of a neutral context may facilitate the
comprehension of the strategic complexities usually involved in signaling games
speeding up the learning process and acting as a partial substitute for experience (weak
context effect), or may even affect the equilibrium selection of subjects (strong context
effect). Cooper, et. al. [8] also points out that a meaningful context applied to subjects
with field experience in the signaling phenomena under study may trigger the use of
strategies looked as familiar. Because we run the experiment with students the use of a
meaningful context can only be justified on the grounds of comprehension. A
meaningful context could be a very useful alternative to look at in experiments that
study specific signaling phenomena with policy implications because of the possibility
of strong context effects. 8 Hence we run some sessions under a meaningful context and
some sessions under a neutral context. Table 4 summarizes our experimental design.
9
For example, Cooper, Kagel, Lo and Wu [8] use both meaningful and neutral contexts to study the
existence of the ratchet effect for managers in centrally commanded production activities.
10
3. Experimental Procedures
The experimental sessions were conducted by hand in campus “Andrés Bello” at the
University of Chile.9 This campus concentrates students from the careers of accounting,
commercial engineer, architecture, geography and design. Each experimental session
employed 12 inexperienced subjects recruited from the first three years of each career.
A total of sixteen sessions were conducted under four treatment conditions outlined in
Table 4 between October 2003 and August 2004. A common set of instructions were
read out loud, with each subject having a written copy. All participants were required to
fill out a short questionnaire to ensure their ability to understand the structure of the
game and correctly calculate their payoffs; right answers were read out loud and
remaining questions answered.10
The participants were conducted to another room and randomly assigned to cubicles
with no direct contact with other participants to keep the privacy. Before a session
begins the participants had some minutes to read a short written summary with the most
important information and rules of the game; more remaining questions were answered.
The summary was available and could be checked at any time.
In the Full Information treatments we included in the instructions (and summary) the
probability of Bad service detection for each type, according to the sign of PH - PL. This
information was displayed in the text and graphically.12 In the None Information
treatments no probabilistic information was displayed; instead it was told that both
types of SRO could sometimes detect members providing a bad service but the number
of times it happens could be equal or different for each type.
9
It was the first time an experimental activity was conducted in Chile and there wasn’t a laboratory with
previous experience in economic experiments available. In view of the limitations we decide to conduct
the experiment by hand to minimize errors. Before the full experimental sessions were conducted we run
six paid pilots to correct the structure and instructions.
10
In the questionnaires the overall correct answer rate for all sessions was of 90% (ranging from 85 to
96% in individual sessions). The rules and structure questions had a correct answer rate of 89% for all
sessions (ranging from 83 to 95%). The payoff questions had a correct answer rate of 91% (ranging from
83 to 96%).
11
In the neutral context sessions we use a common Player A – Player B wording structure. Player A
must find red balls (without looking) in a bowl with white and red balls. She can face two equally likely
situations: 1) she may have a bowl with lots of red balls but is constrained to pick up few balls (with
reposition) generating an “A lot of Reds – Pick up few” (L) type; or 2) she may have a bowl with few red
balls but can pick up a lot of balls, generating a “Few Reds – Pick up a lot” (H) type. The rest of the
structure is equivalent to the meaningful context.
12
At the instruction reading stage we spend one minute to look carefully at the graphic. The same
graphic appears later in the summary.
11
Every session lasts for 42 rounds, except for two sessions that lasts for 36 rounds. We
didn’t tell the participants how many rounds the session lasts to avoid last period
behavior. No dry runs were conducted; instead the first 12 rounds were run at a very
low pace.
At the beginning of the session each participant was randomly assigned with a role
(Public or Organization) and each Organization was randomly assigned with a type such
that there were six participants for each role and three for each type. These roles and
types were fixed within a block of six rounds where each Public was paired with a
different Organization.13 Every six rounds the roles and types were randomly and
privately reassigned for another block until the end of the session.
We limit the possibility of a long repeated sequence of the same role in participants by
imposing a probability of 0.05 of having the same role for more than two consecutive
blocks.14 We also favor those configurations where participants experienced both types
of Organization earlier, given the short number of rounds.
We made in advanced the assignment of roles and types by block for each session (for
each participant numbered from one to 12). We also simulate and establish in advanced
the bad service discoveries for each Organization and the lottery outcome if the Public
chooses “I am undecided” for each round.15
13
We have two random variables for each Organization at the beginning of the game: her type and Bad
service discover. Fixing the type while randomizing Bad service discoveries helps the association of
types with their discover prevalence especially in the None Information sessions.
14
We didn’t set this probability to zero because we were concerned about the veracity of telling our
participants that role assignments were randomized at each block as this breaks the coordinating
mechanism (we didn’t enter in all the details of the assignment mechanism with them). The first two
blocks were completely randomized; for subsequent blocks we firstly set the roles for those with two past
consecutive ones using the rule and distribute the remaining roles at random.
15
We calculate all the combinations of two and eight successes in ten trials. For each Organization and
block we randomly chose one combination and used the first six trials to set a sequence of bad service
discoveries. Hence with Pi = 0.2 (i = H, L) an Organization may find in no more than two occasions per
block, and with Pi = 0.8 the SRO may not find in no more than two occasions. This is better than use Pi
to set discoveries at each round as this avoid sequences with more than two discoveries or not discoveries
in six trials respectively which may cause noise and confusion among participants.
12
At the beginning of each round the Organizations had a written card divided in three
parts. In the left part was written her type and if she could or couldn’t discover bad
service at that round. In the right upper part there was an empty box next to a message
indicating “I have found members giving a bad service”. In the right lower part there
were three empty boxes next to messages indicating three possible opinions: “I think
she is (H)”, “I think she is (L)”, “I am undecided”. The card was partially cut so the
left and right parts could be easily separated.
Only when bad service is discovered the Organization decides if she marks or not the
box in the right upper part (marking the box indicates exposure). We explicitly penalize
in cash any false exposure (we remembered this in the summary and the card).
The Organization removes the right part of the card and sends it to the Public.
Observing the card the Public marks one of the boxes in the lower part and sends it back
to the Organization. We had to train and pay eight graduate students as laboratory
assistants and use three of them at each session.
Hence at each round the Public observed if the Organization whom she was paired with
denounces anything or not, the Organization observed back the Public’s opinion but the
Public didn’t observe if her opinion was right or wrong.
In addition to the summary, all the participants had a Record Sheet where they could
and did register the events, like the role and type they had in each block, and the
decisions they made and received from other participants at each round.
In early pilots were observed an unusual concentration of fraud exposure at the end of
each block of six rounds when all rounds were paid. We control for wealth effects by
randomly choosing and paying one round for each block of six rounds.16
For each round we set U and W equal to $ 2.400 Chilean pesos (USD$ 3.9) for the Full
Information sessions and equal to Ch$ 2.600 (USD$ 4.2) in the None Information
sessions. A typical session lasts for 2 hours (only the rounds last for 85 minutes).
As a developing country Chile has a lower opportunity cost for students than other
developed countries where experimental investigations are usually conducted; this can
be inferred from the Power Purchasing Parity index, the minimum legal wage at Chile
and the mean first job wage for professionals graduated at the campus.17
We also have a very good measure of the opportunity cost per hour for our pool of
students in the rates of the Survey Unit.18 The Survey Unit frequently offers part time
jobs for students paying a maximum rate of Ch$ 2.500 (USD$ 4.1) per hour. Our
participants won, including the showing up fee, a mean of Ch$ 10.600 (USD$ 17.3) per
session. We also had an 86% of our participants winning between Ch$ 5.000 (USD$
16
In fact the same participants chose these rounds using a dice at the end of the session.
17
The World Bank Power Purchasing Parity conversion index for the year 2000 (2001) was of 0.56
(0.47) for Chile, 0.70 (0.70) for Spain [3], 1.03 (1.00) for US, 1.02 (1.03) for the United Kingdom and
0.23 (0.23) for China [8]. The minimum legal wage at Chile in 2004 was Ch$ 114.000 (USD$ 186) a
month (48 hours a week). The mean first job wage for a commercial engineer in 2004 was Ch$ 500.000
(USD$ 814) a month.
18
The Survey Unit is a dependence of the Microdata Center: http://www.microdatos.cl/index.php
13
8.1) and Ch$ 16.800 (USD$ 27.4).19 We considerably raised the payoffs in one Full –
Negative session (not considered in the preceding payoff analysis) with a mean payoff
of Ch$ 16.300 (USD$ 26.5) and observed behavior undistinguishable to comparable
sessions.
After each session the participants could check their payoffs looking at a detailed
summary with Public’s opinions, lottery results and types of Organization ordered by
numbers of participants and groups for each round.
4. Experimental Results
As mentioned in section 2, the Full Information sessions can be seen as the long run
situation for the None Information sessions if any adjustment process occurs in the later
because of the experience with the underlying structure, but more important they
constitute a cleaner environment to test the effect of the sign of PH – PL on participants’
behavior.
Figure 3 depicts the development of play over time for Full Information sessions. The
figure shows the observed proportions of play classified in PH – PL > 0 (grey bars) and
PH – PL < 0 (black bars) sessions, and also classified in sessions conducted under a
meaningful context (dotted bars) and a neutral context (squared bars). The proportions
for each session presented in the Figure come from pooled observations for the first
block of six rounds and for every two-consecutives blocks.
Five graphs are shown in Figure 3: the first graph shows the proportion of fraud
exposure for each session (in deviations from 50%); the second graph shows the
difference in the proportions of “H” and “L” responses when fraud is exposed, a
positive value indicates a prevalence of H over L responses and the maximum value of
100% indicates a full observation of H over L (and uncertain) responses, a negative
value indicates a prevalence of L over H responses and the minimum of -100% indicates
a full observation of L over H (and uncertain) responses; the third graph shows the level
of “Uncertain” responses when fraud is exposed; the fourth graph shows the difference
in the proportions of “H” and “L” responses when fraud is not exposed and its
interpretation is the same as in the second graph; finally, the fifth graph shows the level
of “Uncertain” responses when fraud is not exposed. These graphs put in evidence the
existence of a strong difference in behavior between both signs of PH – PL.
On the top of Tables 5 to 7 are shown the observed proportions (or difference in
proportions) of play for blocks 1, 2-3, 4-5 and 6-7 pooled across sessions according to
the sign of PH – PL and context. Below them are shown four Probit models with random
effects (to control for unobserved heterogeneity) that recover the main features of the
data. The dependent variable in Table 5 is the SRO decision to expose (1) or not expose
(0) fraud when it is found. The dependent variable in Table 6 is the Public’s decision to
respond “H” (1) or “L” (0) when fraud is exposed. The dependent variable in Table 7 is
19
No programmed session had to be cancelled because of lack of participants. In the experimental
sessions where announcements through the campus were used we had a mean of 30 different subjects
showing up on time even with a low showing up fee of Ch$ 800, sometimes having two sessions on the
same week. This was enough even to have some sessions with participants invited only by e-mail.
14
the Public’s decision to respond “H” (1) or “L” (0) when fraud is not exposed.20 In all
of the Tables were used the same independent variables.
In Model 1 we include seldom dummy variables for blocks 1-2-3, 4-5 and 6-7 interacted
with a dummy for the Full – Negative or Full – Positive treatment to identify any
difference. Note that because the dummies don’t vary across individuals and Ф (0) =
0.5 the sign of the estimated coefficients indicates the direction of play in each
treatment with respect of a midpoint (a 50% level of fraud exposure in Table 5 and an
equal proportion of H and L responses, i.e. a difference of 0%, in Tables 6 and 7). A
positive coefficient for any treatment indicates that its behavior is over the midpoint and
a negative coefficient indicates that it is under the midpoint. The significance of the
coefficient indicates if the behavior is statistically different from the midpoint and its
magnitude indicates how far the behavior is from the midpoint. Model 2 uses the same
variables as Model 1 and drops the first block of six rounds to serve as the basis of
comparison for Models 3 and 4.
Note that the block-dummies for each treatment included in Models 1 and 2 recover not
only the effect of PH – PL in mean behavior but also recover any mean adjustment in
reaction to other players’ decisions. Therefore if we want to know the effect of PH – PL
we need to identify and control for the existence of any mean adjustment process. In
Model 3 we include the same blocks-dummies in Models 1 and 2 and incorporate three
additional variables: the mean proportion of fraud exposure for each block (Ann), the
difference between the mean proportions of H and L responses when fraud is exposed
for each block (HLa), and the difference between the mean proportions of H and L
responses when it is not exposed for each block (HLn), all of them lagged one block.
The use of aggregate mean variables is justified for our experimental design because the
modified block random structure makes uncertain who participants had and will have
which role and type in past and later blocks inducing subjects to think more in terms of
aggregate behavior.
Note that for a given block of six rounds a subject with a role of SRO or Public could
have experienced a different role or the same one in the previous block. Therefore if the
subject had a different role in the previous block he/she also had the opportunity to
observe others’ decisions in the role that he/she shares in this block; otherwise if the
subject had the same role she then experienced others’ decisions in the role he/she will
face in this block. In both cases the subjects may use this experience to built
conjectures over aggregate mean behavior and adjust their own behavior; thus we
expect that the aggregate mean variables capture any mean adjustment in reaction to
past collective behavior. As long as mean past behavior is correlated with actual
behavior these variables may also capture adjustments due to expected play for current
blocks.21
In Model 3 we don’t separate the aggregate mean variables by treatment. However any
adjustment may be more pronounced or only significant for one of the treatments or
each treatment may have a different adjustment process. Therefore Model 4 is the result
of a two step procedure: in the first step we include and estimate each aggregate
variable by treatment and keep those significant at the 20% level; in the second step we
20
These Tables have a direct correspondence with graphs 1, 2 and 4 of Figure 3.
21
For example, exposure could be encouraged if subjects believe that “H” opinions will prevail over “L”
opinions when fraud is exposed given past behavior. For the SRO the HLa and HLn variables could also
recover aggregate reactions to expected payoffs.
15
re-estimate the model with the significant variables and keep only those significant at
the 10% level. This procedure was fairly robust to other levels of cut-point significant
levels and always chose the same variables. Generally a significant aggregate effect in
Model 3 was also significant but only for one of the treatments in Model 4.22 In this
way we identify the aggregate variables’ effects for the correct treatments.
Once any adjustment process is controlled for in Model 4 the block-dummies for each
treatment recover most of the effect of the sign of PH – PL over participants’ behavior.
We test two null hypotheses for the presence of this effect in Table 8: the first one is
that all of the block dummies are common across treatments; the second one is that the
1-2-3 block-dummy is common between treatments. The log-likelihood for the base
and restricted models, the χ2 statistic and its p-value are presented in the Table.
Conclusion 1 (effect of the sign of PH – PL): None of the expected proportions of play
in Table 3 were strictly played. However there is a clear difference in behavior due to
the sign of PH – PL. For PH – PL < 0 sessions a BAD interpretation has more empirical
support than a GOOD interpretation. For PH – PL > 0 sessions a GOOD interpretation
has more empirical support. What is common for both signs is that subjects chose less
“uncertain” responses when fraud is exposed than when it is not.
As can be seen in Figure 1 and Table 9, where the proportion of play for each strategy
(with a 95% confidence interval) was calculated by pooling entire sessions, none of the
proportions of play in Table 3 reproduced in the last two columns of Table 9 were
strictly performed.
However for PH – PL < 0 the observed proportions of play were closer to the expected
proportions under a BAD interpretation: the proportion of fraud exposure wasn’t 0%
but was low (30% in mean as shown in Table 9) and the H responses when fraud was
exposed were substantially lower than the L responses (67 percent points lower). Under
a BAD interpretation the H and L responses when fraud is not exposed are not
constrained however we can see in the Table that the H responses were higher than the
L responses (27 percent points higher) favoring the equilibrium of Figure 1b.
For PH – PL > 0 the observed proportions of play were closer to the proportions of play
of a GOOD interpretation: the proportion of fraud exposure wasn’t 100% but was quite
22
There is always a statistically significant (at 5% level) improvement between Models 2 and 4.
Comparing Models 3 and 4 log-likelihoods there is almost no loose of information between them (in fact
a remarkable improvement occurred in Table 7).
16
high (92% in mean), the H responses when fraud was exposed were substantially higher
than the L responses (78 percent points higher), and the H responses when fraud was
not exposed were substantially lower than the L responses (58 percent points lower).
In Table 8 we test any difference in behavior for both the SRO and the Public that can
be attributable to the sign of PH – PL (once any adjustment process is controlled for) and
we can accept at conventional levels the presence of a systematic difference in the
behavior of both roles in the direction observed in Figure 1 and Table 9.
When fraud was exposed few “uncertain” responses were observed (8% of the
responses for Full – Negative sessions and 5% for Full – Positive sessions) which
suggests a general preference to risk a choice in this case. On the contrary the
“uncertain” responses when fraud wasn’t exposed were higher (17% and 14%
respectively) which may indicate a higher mean difficulty to interpret a no exposure,
especially for the Full – Positive sessions where the Bayes rule fully identified an
optimal response (always say “L”).
Conclusion 2 (behavior in the Full – Negative sessions): The low level of fraud
exposure can be partly explained as a reaction to the prevalence of L over H responses
when fraud is exposed. The preference of L over H responses when fraud is exposed
has an inverted U – shaped pattern: at the beginning L responses are more favored
over H responses, at intermediate rounds L responses drop (and H rise) in frequency
but they strongly rise again at final rounds. This pattern is not explained as a reaction
to aggregate behavior. The preference of H over L responses when fraud is not exposed
tends to grow over time and is partly self-encouraged and partly encouraged by the
presence of fraud exposure.
As the sign of HLa for the Full Negative treatment in Model 4 of Table 5 indicates a
higher mean level of L over H responses when fraud isn’t exposed affects the SRO’s
mean behavior in the next block. Comparing the block-dummies for this treatment in
Models 2 and 4 we can observe an increase in the likelihood of fraud exposure (less
negative block-dummies) once this effect is controlled for, suggesting that the mean
30% of fraud exposure in Table 9 is partly uphold by the Public’s preference for L over
H responses when fraud is exposed.
As can be seen in Figure 1 the difference in the proportion of H vs. L responses strongly
favors the later. However a regular pattern can be observed in most of the sessions: in
the first block of six rounds the public strongly favors L over H responses, at
intermediate blocks the proportion of L responses drop and the proportion of H
responses rise (except for one session where the uncertain responses strongly rose in
blocks 2-3) but at final blocks the proportion of L responses strongly rise again. In
Model 4 of Table 6 there is no significant aggregate variable for this treatment thus the
full pattern cannot be explained as a reaction to past behavior. In a survey conducted at
the end of some of these sessions some subjects declared that they understood that an
exposure is more likely to come from a SRO type L thus they didn’t understood why an
exposure could ever happen in the first place, suggesting that the U-shaped pattern
could be partly explained as the result of confusion at intermediate blocks due to the
very presence of exposure and the absence of any feedback for the Public’s decisions
(this could explain the high level of uncertain responses in the session mentioned
before), but this phenomenon eventually disappears as the information of PH – PL
becomes more prevalent on decisions.
17
For this treatment subjects are free to set any belief when fraud is not exposed thus no
pattern is previously expected. In Figure 1 and the top of Table 7 we observe that in all
but one session an H response was mostly preferred to an L response when fraud was
not exposed in the first block of six rounds. In the next two blocks we see decay in this
preference for some sessions and a steady growth for later blocks. In Model 4 of Table
7 we observe that two aggregate variables were significant for this treatment: HLn and
Ann. From the block-dummies in Models 2 and 4 we can infer that these aggregate
variables are capable to explain all the observed growth for later blocks (in Model 2 the
block-dummies captures a strong growth but in Model 4 actually no significant growth
is captured).23 The sign of HLn suggests that the observation of higher levels of H over
L responses in the past encourage subjects to respond H more likely than L in later
blocks.24 The sign of Ann indicates that higher past levels of fraud exposure increases
the likelihood of H responses over L responses in later blocks (this suggest that
experiencing fraud exposure in this treatment make subjects think more also over the no
exposure scenario).25 In our view these findings suggest that a rise in the levels of H
over L responses when fraud is not exposed, which gives some support to the Pareto
equilibrium in Figure 1b, is not fueled by the knowledge of the sign of PH – PL but it’s
the result of an underlying and self sustained adjustment process.
Conclusion 3 (behavior in the Full – Positive sessions): The high levels of fraud
exposure cannot be explained as a reaction to aggregate behavior. The high preference
of H over L responses when fraud is exposed is strongly self-encouraged. The
preference of L over H responses when fraud isn’t exposed is inhibited by higher levels
of H over L responses when fraud is exposed.
In Model 4 of Table 5 there is no significant aggregate variable for this treatment thus
the high proportions of fraud exposure in Table 9 (92%) cannot be explained as a mean
reaction to past aggregate behavior but it must be mainly driven by the sign of PH – PL.
Table 9 shows a high prevalence of L over H responses when fraud isn’t exposed.
However, as can be inferred from the sign of HLa for this treatment In Model 4 of Table
7 subjects will respond H more likely than L if in the aggregate H is preferred over L
when fraud was exposed; the blocks-dummies for this treatment in Models 2 and 4
suggest that in the absence of this reaction the likelihood of L over H responses strongly
rises (we belief that the aggregate variable is capturing the emergence of a particular
intermediate individual behavior that will be discussed in part D).
23
Each aggregate variable explains almost half of the mean growth: if HLn is not added in Model 4 the
estimated block-dummies are 0.027, 0.155 and 0.391 respectively (log-likelihood: -489.015).
24
This may be principally driven by those subjects who experienced the role of SRO in the previous
block.
25
A simple logic consistent with this finding is that because an exposure is more likely to come from a
SRO type L a no exposure is more likely to come from a SRO type H.
18
Figure 3: FULL INFORMATION SESSIONS
SRO: % DIFFERENCE BETWEEN FRAUD EXPOSURE AND 50 %
25.0
PERCENT
0.0
-25.0
-50.0
1 2-3 4-5 6-7
BLOCKS OF 6 ROUNDS
50.0
PERCENT
0.0
-50.0
-100.0
1 2-3 4-5 6-7
BLOCKS OF 6 ROUNDS
75.0
PERCENT
50.0
25.0
0.0
1 2-3 4-5 6-7
BLOCKS OF 6 ROUNDS
100.0
50.0
CENT
0.0
PER
-50.0
-100.0
1 2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
100.0
75.0
PERCENT
50.0
25.0
0.0
1 2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
19
Table 5: FULL INFORMATION
FRAUD EXPOSURE WHEN FRAUD IS FOUND
PH - PL NEGATIVE POSITIVE
Blocks All Meaningful Neutral All Meaningful Neutral
1 0.324 0.273 0.474 0.778 0.730 0.882
2-3 0.309 0.286 0.382 0.918 0.878 1.000
4-5 0.322 0.377 0.179 0.973 0.972 0.974
6-7 0.273 0.300 0.111 0.927 0.884 1.000
20
Table 6: FULL INFORMATION
“H” vs “L” OPINIONS WHEN SRO EXPOSES FRAUD
PH - PL NEGATIVE POSITIVE
Blocks All Meaningful Neutral All Meaningful Neutral
1 -0.667 -0.600 -0.778 0.690 0.704 0.667
2-3 -0.465 -0.433 -0.538 0.723 0.662 0.833
4-5 -0.478 -0.436 -0.714 0.766 0.686 0.919
6-7 -0.800 -0.788 -1.000 0.891 0.885 0.900
21
Table 7: FULL INFORMATION.
“H” vs “L” OPINIONS WHEN SRO DOESN’T EXPOSE FRAUD
PH - PL NEGATIVE POSITIVE
Blocks All Meaningful Neutral All Meaningful Neutral
1 0.225 0.237 0.185 -0.591 -0.578 -0.619
2-3 0.152 0.204 -0.017 -0.539 -0.570 -0.472
4-5 0.301 0.379 0.081 -0.620 -0.630 -0.600
6-7 0.382 0.432 0.118 -0.583 -0.723 -0.219
22
Table 8: Effect of the sign of P H – P L in Full Information sessions
Therefore in the None Information sessions we have the great opportunity to investigate
if human subjects 1) are capable to learn the underlying PH and PL of a credence market
(i.e. the underlying structure of the game), and 2) are capable to react to the structure
and adjust their beliefs and behavior in the direction observed under the Full
Information sessions. Hence the analysis will mainly focus in the behavior of the first
and last blocks of six rounds and will maintain the control of adjustment processes
made in part A to better separate any effect of the experience and learning of the
structure on behavior.
23
Figure 4 depicts the development of play over time in None Information Sessions. The
figure shows the proportions of play for each session classified as in Figure 1 (grey for
Positive sessions, black for Negative ones, dotted bars for meaningful context sessions
and squared bars for neutral context ones).
Six graphs are shown in Figure 4: the first graph shows the observed proportion of play
in the first block of six rounds for each session (the proportion of fraud exposure and
the difference between the proportions of “H” and “L” responses when fraud is and is
not exposed), in this block we don’t expect any systematic difference in sessions with
different sign of PH – PL (but may be a difference because of the context). The first
block behavior has a lot of variance among sessions thus most of the following graphs
display the proportions of each session in deviations from the first block proportion to
clarify the existence of patterns. The second graph shows for later blocks the deviations
from the first block proportion of fraud exposure; the third graph shows for later blocks
the deviations from the first block difference between proportions of “H” and “L”
opinions when fraud is exposed; the fourth graph shows the proportion of “uncertain”
responses when fraud is exposed; the fifth graph shows for later blocks the deviation
from the first block difference between proportions of “H” and “L” opinions when fraud
isn’t exposed; and the sixth graph shows the proportion of “uncertain” responses when
fraud isn’t exposed.
In Figure 4 we can observe a different behavior for blocks 6-7 between None –
Negative and None – Positive treatments.
The four None – Negative sessions show a lower mean rate of fraud exposure at final
blocks compared with their first block proportion however the reduction is stronger for
some sessions and weaker for others (indeed we have one session with a strong
reduction and one with a weak reduction under both contexts). Three of five None –
Positive sessions show a weak reduction in the rate of fraud exposure compared with
their first block proportions and two show an increase.
All but one (meaningful context session) of the None – Negative sessions show at final
blocks a reduction in the difference between H and L responses when fraud was
exposed with respect to the first block difference; those which fell end with a negative
difference rate (between -33% and -57%) indicating a preference of L over H responses
when fraud is exposed at final blocks. All but one (neutral context session) of the None
– Positive sessions show at final blocks an increase in the difference with respect to the
first block; those which rose end with a positive difference rate (between 5.3% and
57%) indicating a preference of H over L responses when fraud is exposed at final
blocks.
All but one (meaningful context session) of the None – Negative sessions show at final
blocks an increase in the difference between H and L responses when fraud is not
exposed with respect to the first block difference; all of them end with a positive
difference rate (between 4% and 37%) indicating a preference of H over L responses
when fraud was not exposed at final blocks. All but one (neutral context session) of the
None – Positive sessions show at final blocks a reduction in this difference with respect
to the first block; those which fell end with a negative difference rate (between -10%
and -27%) indicating a preference of L over H responses when fraud is exposed at final
blocks.
24
It can also be seen in the Figure that the Uncertain responses where lower when fraud is
exposed than when it is not exposed (a pooled mean of 9% vs. 23%). Similar rates were
observed for Full Information sessions supporting the view of a general preference to
risk a choice when an exposure happens and the presence of a higher difficulty to
interpret a no exposure respectively.
In the top of Tables 10 to 12 are shown the observed proportions (or difference of
proportions) of play for blocks 1, 2-3, 4-5 and 6-7 pooled across sessions according to
the sign of PH – PL and context, and four probit models with random effects that recover
the main features of the data. The dependent variables in Tables 10, 11 and 12 coincide
with those of Tables 5, 7 and 8 respectively.
For these Models we use slightly different independent variables than part A. Model 1
is the result of a two step procedure: in the first step we include a dummy for block 1, a
dummy for neutral context sessions in block 1, dummies for blocks 2-3, 4-5 and 6-7
interacted with a dummy for the None – Negative or the None – Positive treatment. We
also add additional block-dummies for each treatment conducted under a neutral
context. The block 1-dummy recovers the mean first-block behavior for meaningful
context sessions. The block 1-dummy for neutral contexts sessions recovers any
deviation in the first-block behavior due to the use of a neutral context. The block-
dummies for each treatment have the same use and interpretation as in part A. The
additional block-dummies for treatments conducted under a neutral context recover any
deviation over time due to the use of a neutral context. In the second step we restrict the
model and eliminate the non significant block-dummies for treatments conducted under
a neutral context.1 Model 2 uses the same variables as Model 1, except the block 1
dummies, and drops the first block of six rounds to serve as the basis of comparison for
Models 3 and 4.
In Model 3 we include the same aggregate variables used in part A. These aggregate
variables recover participants’ mean reactions to aggregate behavior as these may
confound the real effect of experience and learning of the structure on behavior (it could
be that the observed patterns of play are principally influenced by these reactions and
not by the experience with the underlying PH and PL). In Model 4 we follow the same
two step procedure as in Part A but in the first step we expand the aggregate variables
by treatment and context.
Once any mean adjustment process is controlled for in Model 4 the dummies for blocks
and treatments recover most of the effect of the experience and learning of the structural
PH and PL over participants’ behavior. We test the existence of any effect for each
context in Table 13: focusing in behavior at blocks 6-7 we test the null that this block
dummy is common among treatments. The log-likelihood for the restricted model, the
χ2 statistic and its p-value are presented in the Table.
Conclusion 4 (context effects): Subjects under a meaningful context are more likely to
expose fraud in the first block of six rounds than subjects under a neutral context. For
1
The imposed restrictions were largely accepted at conventional significance levels (LRT and z-tests).
25
the None – Positive treatment the neutral context sessions show a lower mean rate of
fraud exposure and a lower rate of H over L responses when fraud is exposed with
respect to meaningful context sessions in later blocks. For the None – Negative
treatment the neutral context sessions show a lower mean rate of fraud exposure in final
blocks.
The mean proportion of fraud exposure in the first block of six rounds for neutral
context sessions was 61% and for meaningful context ones was 75% thus many subjects
initially prefer to expose fraud in both contexts. The block 1 – neutral context dummy
in Model 1 of Table 10 is negative and significant at the 5% level corroborating a lower
likelihood of fraud exposure in neutral context sessions with respect to meaningful
context sessions. The same dummy is not significant in Tables 11 and 12 indicating the
absence of any starting difference in the Public’s behavior because of the context. This
indicates the presence of a moderate context effect for the SRO and none for the Public
in their starting behavior.
In later blocks there is a clear context effect in both the SRO and Public’s behavior for
the None – Positive treatment. The neutral context sessions always show a lower mean
rate of fraud exposure with respect to meaningful context sessions (40% vs. 61% in
blocks 2-3, 51% vs. 82% in blocks 6-7) and a lower mean difference in the rate of H vs.
L responses when fraud is exposed (a difference of –23% vs. 42% in blocks 2-3, a
difference of 0% vs. 51% in blocks 6-7); the neutral context sessions also show a lower
negative slope in the mean difference of H vs. L responses when fraud isn’t exposed
(the difference decays from 2% to -9% in neutral context sessions and from 33% to –
20% in meaningful context sessions). The block-dummies for the None – Positive
treatment under a neutral context in Models 1, 2 and 4 of Tables 10, 11 and 12 capture
these differences in behavior; for Tables 10 and 11 they are significant and negative
however for Table 12 there isn’t any statistical difference in the negative slope between
contexts (thus we pooled them).
For the None – Negative treatment under a neutral context there is a lower mean rate of
fraud exposure in final blocks (36%) with respect to the meaningful context sessions
(51%). The blocks 6-7 dummy for the None – Negative treatment under a neutral
context in Table 10 recovers this difference (statistically significant in Models 1, 2 and
4). The Public’s behavior showed no statistical difference across contexts for the None
– Negative treatment (thus both contexts were pooled).
As can be seen at the top of Tables 10 to 12 there is a difference for the last two blocks
between the None – Positive and the None – Negative treatments under a Meaningful
context. At these blocks the mean level of fraud exposure is 81% for the None –
Positive and 51% for the None – Negative treatment. The difference in the mean rates
26
of H and L responses when fraud is exposed are 52% and -15% respectively, indicating
that in the None – Positive sessions an H response is preferred to an L response and that
in the None – Negative sessions the opposite happens. The difference in the mean rates
of H and L responses when fraud is not exposed are -20% and 25% respectively,
indicating that in the None – Positive sessions an L response is preferred to an H
response in this case and that in the None – Negative sessions the opposite also
happens.
In Tables 10 to 12 we can also observe a difference in behavior for the last two blocks
between the None – Positive and the None – Negative treatments under a Neutral
context. The corresponding mean levels of fraud exposure are 51% for the None –
Positive and 36% for the None – Negative treatment. The difference in the mean rates
of H and L responses when fraud is exposed are 0% and -33% respectively, indicating
that in the None – Positive sessions there is no preference between H and L responses
and that in the None – Negative sessions there is a preference for L over H responses.
The difference in the mean rates of H and L responses when fraud isn’t exposed are -9%
and 31% respectively, indicating that in the None – Positive sessions an L response is
preferred to an H and that in the None – Negative sessions the opposite happens.
In the third column of Table 13 we test for the presence of any significant difference
between the None – Positive and None – Negative treatments for the Neutral context
sessions. We can accept at the 5% level a significant difference in the Public’s behavior
among treatments but we can’t for the SRO. However if we make a direct comparison
of the proportions of fraud exposure in blocks 6-7 between the None – Negative and
None – Positive treatments we cannot reject at the 10% level the existence of a lower
proportion in the former (χ2-stat (d.f.=1) = 3.215, p-value=0.073). We cannot reject it
at higher levels because of the low rate of fraud exposure in the None – Positive
sessions. As can be seen in Model 4 of Table 9 the aggregate variables for Neutral
context sessions were not strong enough to produce a very different likelihood of fraud
exposure for blocks 6-7 to that of Model 2 (the aggregate variable was only marginally
significant) thus the absence of a significant difference only arises once the
heterogeneity among subjects is taken into account (indeed in Model 2 there isn’t a
significant difference either).
27
For Neutral context sessions the reduction in the proportion cannot be explained as a
reaction to aggregate mean behavior. For both contexts a higher mean level of fraud
exposure inhibits the rise of L over H responses when fraud is exposed. For meaningful
context sessions the prevalence of H over L responses when fraud isn’t exposed is partly
self-encouraged.
In Model 4 of Table 10 the sign of HLa for the None – Negative treatment under a
meaningful context suggests that a higher mean level of L over H responses when fraud
is exposed affects the SRO’s behavior in later blocks. Comparing the block-dummies
for this treatment in Models 2 and 4 there’s an increase in the likelihood of fraud
exposure for the last two blocks in the later once this effect is controlled for (more
positive block-dummies), suggesting that the 51% of mean fraud exposure for these
blocks is partially sustained as a reaction to the prevalence of L over H responses when
fraud is exposed. The None – Negative treatment under a Neutral context do not exhibit
any significant aggregate variable, hence the marginal reduction observed in the last
blocks of these sessions can be mostly attributable to the experience with the structure.
As can be seen in Model 4 of Table 11 for the None – Negative treatment under both
contexts the Ann variable is significant suggesting that a Higher mean level of fraud
exposure increases the likelihood of an H over an L opinion when fraud is exposed in
later blocks.2 More important, comparing the block-dummies for the None – Negative
treatment in Models 2 and 4 we can observe in the later an important decrease in the
likelihood of fraud exposure for all blocks once this effect is controlled for. Indeed in
Model 4 the block-dummies become significant and also show a decreasing pattern
suggesting a stronger mean effect of the experience with the structure. The Ann
variable could capture a noisy effect caused by fraud exposure over the Public’s
reasoning process especially for the last blocks when subjects have experienced the
structure of the game (the information learned from the structure, i.e. an L type finds
fraud more times than an H type, enters in conflict with the fact that many subjects are
exposing fraud causing confusion).3 Remember that for the Meaningful context the
HLa variable also affects the likelihood of fraud exposure in later blocks (Table 10)
suggesting the existence of a feedback (or path dependent) process that could sustains,
for example, higher levels of fraud exposure with higher levels of H over L responses in
later blocks (as was the case in one of the sessions). For the Neutral context we didn’t
identify such a feedback thus only the noisy effect for the Public is in place (evidence of
a strong context effect).
For the None – Negative treatment under Meaningful context we observe in Model 4 of
Table 12 that HLn is significant. The sign of HLn indicates that the observation of
higher levels of H over L responses in the past rises the likelihood of an H over an L
response in later blocks. From the block-dummies for the None – Negative treatment
in Models 2 and 4 we can infer that this aggregate variable explains part of the high
levels of H over L responses in all blocks; the block-dummies in Model 4 also suggest a
growing likelihood of H over L responses that can be mostly attributable to experience
with the structure. This finding is consistent with that observed for Full Information
2
This aggregate variable was significant and had almost identical estimated coefficients for both context
thus we pooled them together to obtain a more precise estimate.
3
In a survey conducted at the end of some of these sessions (especially in the meaningful context
sessions) some subjects declared that they exposed sometimes fraud trying to manipulate the Public’s
behavior.
28
sessions, giving more support to the equilibrium in Figure 1b, which for this level of
information is fueled by a self sustained adjustment process and experience with the
structure.
In Model 4 of Table 10 there is no significant aggregate variable for the None – Positive
treatment under a meaningful context suggesting that the growth in the level of fraud
exposure observed for blocks 2 to 7 can be mostly attributable to the experience with
the structure. The None – Positive treatment under a neutral context exhibit one
significant (at the 10% level) aggregate variable, HLa, suggesting that a higher mean
level of L over H responses when fraud is exposed affects the behavior of the SRO.
Comparing the block-dummies for this treatment and context in Models 2 and 4 there’s
an increase in the likelihood of fraud exposure only for intermediate blocks once this
effect is controlled for (less negative block-dummies) however there is no clear pattern
of growth in the likelihood of fraud exposure.
As can be seen in Model 4 of Table 11 for the None – Positive treatment under a
meaningful context there is no significant aggregate variable suggesting that the growth
in the level of H over L opinions when fraud is exposed can be mostly attributable to the
experience with the structure (the difference in the mean rates of H and L responses
grows from 12% in the first block to 51% for final blocks). For the neutral context we
didn’t identify any significant aggregate variable either; however the observed pattern
for this context is very different to that of the meaningful context: in both sessions
conducted under a neutral context there is an initial preference of H over L responses
when fraud is exposed at the first block (a difference in the rates of H and L responses
of 10% and 11% respectively), for later blocks the preference switches (for blocks 2-3
there is a difference of –46% and –11% in both sessions) however it decreases for final
blocks (for blocks 6-7 there is a difference of –6% and 5% respectively).
For the None – Positive treatment under a meaningful context we observe in Model 4 of
Table 12 that no aggregate variable is significant suggesting that the increase in the
levels of L over H responses when fraud is not exposed can be mostly attributable to
experience with the structure. The same pattern is observed for the None – Positive
treatment under a neutral context thus the additional block-dummies for this context
were not significant in any Model.
29
Figure 4: NONE INFORMATION SESSIONS
1ST BLOCK BEHAVIOR (NONE INFORMATION)
75.0
PERCENT
50.0
25.0
0.0
-25.0
-50.0
% OF FRAUD EXPOSURE % DIF. "H" - "L" WHEN % DIF. "H" - "L" WHEN
SRO EXPOSES SRO DOESN'T EXPOSE
30.0
PERCENT
0.0
-30.0
-60.0
2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
50.0
CENT
0.0
PER
-50.0
-100.0
2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
75.0
CENT
50.0
PER
25.0
0.0
1 2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
100.0
50.0
RE
CNT
0.0
E
P
-50.0
-100.0
2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
30
Figure 4: NONE INFORMATION SESSIONS
PUBLIC: % "UNCERTAIN" WHEN SRO DO NOT EXPOSE
Positive - Meaningful Positive - Neutral Negative - Meaningful Negative - Neutral
100.0
75.0
C
RENT
50.0
E
P
25.0
0.0
1 2 - 3 4 - 5 6 - 7
BLOCKS OF 6 ROUNDS
31
Table 10: NONE INFORMATION
FRAUD EXPOSURE WHEN FRAUD IS FOUND
PH - PL NEGATIVE POSITIVE
Blocks All Meaningful Neutral All Meaningful Neutral
1 0.724 0.750 0.694 0.667 0.754 0.528
2-3 0.480 0.395 0.566 0.528 0.613 0.405
4-5 0.531 0.438 0.625 0.635 0.752 0.474
6-7 0.412 0.513 0.360 0.690 0.816 0.507
32
Table 11: NONE INFORMATION
“H” vs “L” OPINIONS WHEN SRO EXPOSES FRAUD
PH - PL NEGATIVE POSITIVE
Blocks All Meaningful Neutral All Meaningful Neutral
1 0.164 0.033 0.320 0.113 0.116 0.105
2-3 0.137 0.167 0.116 0.211 0.415 -0.233
4-5 -0.052 -0.250 0.089 0.217 0.380 -0.139
6-7 -0.255 -0.150 -0.333 0.358 0.512 0.000
33
Table 12: NONE INFORMATION.
“H” vs “L” OPINIONS WHEN SRO DOESN’T EXPOSE FRAUD
PH - PL NEGATIVE POSITIVE
Blocks All Meaningful Neutral All Meaningful Neutral
1 0.022 0.048 0.000 0.191 0.328 0.020
2-3 0.219 0.186 0.258 0.026 0.066 -0.026
4-5 0.322 0.348 0.293 -0.112 -0.142 -0.074
6-7 0.296 0.250 0.316 -0.149 -0.195 -0.093
34
Table 12: Effect of the Structure in None Information sessions
C. Informational Effects
In parts A and B was analyzed the general pattern of behavior for each level of
information. In this part we look for differences in behavior because of the level of
Information. Therefore for each sign of PH – PL we estimate a model that includes
blocks dummies for each level of information and context. We look for informational
effects only for Meaningful contexts sessions testing the null of common block-
dummies for all and for the last two blocks (to see if the mean behavior in Full
Information and None Information sessions is the same at final blocks). The tests are
shown in Table 14.
35
exposure, a higher level of H over L responses when fraud is exposed and a higher level
of L over H responses when fraud isn’t exposed than None information sessions. For
each sign of PH – PL the pattern of behavior in None Information sessions becomes
similar at final blocks to that observed in Full Information sessions however there is
still a significant difference in the proportions of play except for the proportion of H
over L responses when fraud is not exposed when PH – PL < 0.
When PH – PL < 0 the proportions presented in Tables 7 and 12 show that for the
Meaningful context there is a higher rate of H over L responses when fraud isn’t
exposed in Full Information sessions than in None Information sessions (in the first
block the mean difference is 24% and 5% respectively, in the last two blocks the mean
difference is 43% and 25%). When PH – PL > 0 the same Tables show a higher rate of L
over H responses when fraud isn’t exposed in Full Information sessions, specially in the
first three blocks of six rounds where the mean rate of H responses is higher than the
mean rate of L responses in None Information sessions (a mean difference of 33% vs. -
58% for Full Information sessions); at the last two blocks the mean difference between
the rates of H and L responses become negative for the None Information sessions (-
20%) however it is still far from the mean difference in Full Information sessions (-
72%).
Table 14 gives statistical support for the existence of a difference in behavior due to the
level of information at all blocks and at the last two blocks. There is a significant
difference (at the 5% level) for all the cases except for the rate of H vs. L responses
when fraud is not exposed for PH – PL < 0 sessions in all blocks and in the last two
blocks.
36
Table 14: Effect of the level of Information & Convergence
PH – PL POSITIVE NEGATIVE
Base model l.l. -425.43 -551.128
PH – PL POSITIVE NEGATIVE
Base model l.l. -320.124 -184.274
PH – PL POSITIVE NEGATIVE
Base model l.l. -601.349 -786.615
Because none of the proportions of play expected in Table 3 were actually observed
even in Full Information sessions we made a further investigation at the individual level
to obtain some guidance to understand these findings.
37
Figure 5 depicts the individual behavior observed under both Full and None Information
levels classified in PH – PL < 0 sessions (black bars) and PH – PL > 0 sessions (grey
bars). The first and second graph in Figure 3 shows the behavior in Full information
sessions for the SRO and Public respectively, the third and fourth graph shows the
behavior in None Information sessions for the SRO and Public respectively (only the
Meaningful context sessions are considered for the None – Positive treatment). The
proportions of individual behavior are also displayed by treatment in Table 15 with the
None – Positive treatment separated by context.
For the SRO role four general forms of behavior were identified: some subjects never
denounced fraud when they found it (negative interpretation behavior), some always
denounced fraud when they found it (positive interpretation behavior), some
denounced fraud always, never or sometimes conditionally on the SRO type
(conditional behavior) and some denounced fraud sometimes whatever the SRO type
(undecided behavior).1
For the Public role five general forms of behavior were identified: some subjects
always responded “L” when fraud was exposed (negative interpretation behavior),
some always responded “H” when fraud was exposed and “L” when it wasn’t (positive
interpretation behavior), some responded “H” when fraud was exposed and anything
(i.e. “H”, “L” or “uncertain”) when it wasn’t exposed (quasi-positive interpretation),
some responded anything when fraud was exposed and when it wasn’t (undecided
behavior), and few responded anything when fraud was exposed and “L” when it wasn’t
(other behavior).
For each role subjects were classified according to the previous forms of behavior.
Many individuals consistently kept the same behavior along the session but some
changed it. Under each form of behavior we included those individuals who kept that
behavior for the entire session together with those who ended the session with that
behavior.
Most of the subjects didn’t have a consistent form of behavior under both roles (indeed
few behaved in opposite directions), thus we analyze both roles in separate. Table 16
gives statistical support to the individual patterns of behavior observed in Figure 5 and
Table 15 (only the Meaningful context sessions are considered for the None – Positive
treatment in these tests).
1
Conditional behavior: always denounce as an H type but never as an L type, denounce sometimes as
an H type but never as an L type, denounce sometimes as an H type but always as an L type, and their
converse.
38
behavior for both contexts.2 This is consistent with the results of Part B where the None
– Positive treatment under a neutral context showed a very different mean behavior than
the meaningful context; this of course also represents evidence of a strong context
effect. We will use the None – Positive treatment under a meaningful context to make
further comparisons with other treatments thus when we make use of this treatment the
conclusions will be valid only for its meaningful context.
A closer analysis of the Figure and Tables sustain the following conclusions:
For the SRO role we expected to see a great impact of the sign of PH – PL in subjects’
behavior because they were also able to observe their own payoffs at each round.
As can be seen in the upper half of Table 15 (SRO behavior) for the Full – Negative
treatment 35% of the subjects had or ended with a Negative Interpretation, there is also
a big proportion of subjects with a Conditional behavior (44%), a smaller proportion
with an Undecided behavior (13%) and few with a Positive behavior (8%). For the Full
– Positive treatment 72% of the subjects had or ended with a Positive Interpretation, and
28% had or ended with a Conditional behavior. Table 16 gives statistical support to the
existent differences among treatments for the SRO: there is a higher proportion of
subjects with a negative and undecided behavior in the Full – Negative treatment and a
higher proportion of subjects with a positive interpretation in the Full – Positive
treatment; there is no statistical difference in the proportion of Conditional behavior
among treatments.
This explains why the levels of fraud exposure in the Full – Negative treatment didn’t
collapse to zero as expected in Table 3: 1 of 12 subjects had a positive interpretation,
1.5 of 12 subjects had an Undecided behavior and 5 of 12 subjects believed that a
Conditional behavior was their best strategy as SRO (indeed 35% of the subjects
consistently kept some kind of Conditional behavior for the entire session). The first
two forms of behavior explains approximately half (14.6 points) of the 30% of mean
fraud exposure and the later explains approximately the other half.3 Because we found
2
The individual behavior for the None – Negative sessions under both contexts was similar with no
statistically significant difference (for the SRO the χ2-stat for the null of equal distributions (3.d.f) is 2.47
and for the Public (3.d.f) is 1.56, the 5% critical value is 7.8) thus we pooled them.
3
The expected number of fraud discoveries in each block of six rounds for all subjects is 18. The
expected number of fraud exposure in any block by the subject with a positive interpretation is 1.5. The
expected number of fraud exposure in any block by the 1.5 subjects with undecided behavior (and random
exposure) is 1.125. Therefore the first explains approximately 8.3% of the fraud exposure and the second
explains 6.3%. These are also approximations because some subjects ended the session with some form
of behavior.
39
the first two forms of behavior in both meaningful and neutral contexts sessions they
may be the outcome of a misunderstand of the relevance of the information about PH
and PL, limited rationality or because the structure was unintuitive and leads to
confusion (some subjects may found less intuitive that an L type can find fraud more
times than an H type). The Conditional behavior was also observed under both contexts
however the great proportion of subjects who consistently kept it suggests that it is not
rare but a potential candidate for long run behavior for a part of the population when the
sign of PH – PL is mutual knowledge (maybe caused by limited rationality).
This also explains why the levels of exposure in the Full – Positive treatment were high
but not 100% as expected for a Positive Interpretation in Table 3: 3.4 of every 12
subjects had or ended the session with a Conditional behavior as SRO. The absence of
subjects with a Negative or an Undecided behavior suggests that this environment is
more intuitive for them (an H type finds fraud more times than an L type), giving
support to the view that the Full – Negative treatment represents an unintuitive
environment for some subjects as SRO.4 Even though the proportion of subjects with a
Conditional behavior is lower (but not statistically different) than that of the Full –
Negative treatment it is notable to find it here too and strengths the view of a potential
long run behavior for a part of the population when the sign of PH – PL is mutually
known.
For the Public role we expected a more moderate impact of the sign of PH – PL in
subjects behavior because they were not able to observe the type of the SRO at each
round and should decide only on the basis of these probabilities (thus it demands
reasoning over expected payoffs without feedback).
As can be seen in the lower half of Table 15 (Public behavior) for the Full – Negative
treatment 64% of the subjects had or ended with a Negative Interpretation, there is also
a smaller proportion with an undecided (19%) and quasi-positive (17%) behavior. For
the Full – Positive treatment most of the subjects had or ended with a Positive
Interpretation (44%) or a quasi-positive (39%) behavior, the rest had or ended with
different forms of behavior (only 1 of 36 subjects had a negative interpretation). Table
16 gives statistical support to the existent differences among treatments for the Public:
there is a higher proportion of subjects with a negative interpretation in the Full –
Negative treatment and a higher proportion of subjects with a positive interpretation and
quasi-positive (and other) behavior in the Full – Positive treatment; there is no statistical
difference in the proportion of Undecided behavior among treatments.
4
The instructions were exactly the same for both treatments except for the values of PH and PL.
40
subjects with a quasi-positive and undecided behavior in the Full – Negative treatment
(4.2 of 12 subjects) may be explained as a consequence of the unintuitive environment
in the later.5
As can be seen in the upper half of Table 15 (SRO behavior) for the None – Negative
treatment 15% of the subjects had or ended with a Negative Interpretation (vs. 11% for
the None – Positive treatment), there is also a big proportion of subjects with a
Conditional behavior (52% vs. 44%), a smaller proportion with a positive interpretation
(19% vs. 33%) and Undecided behavior (15% vs. 11%). The second column of Table
16 shows no significant difference among these treatments for the SRO role. It is
noteworthy the high levels of subjects with a Conditional behavior which are higher
than those observed in the Full Information sessions; in view of the previously
discussed for Full information sessions we don’t expect to observe here a complete
decrease in this form of behavior either.
The lower half of Table 15 (Public behavior) shows that for the None – Negative
treatment 48% of the subjects had or terminate with a Negative Interpretation (vs. 8%
for the None – Positive treatment), there are also many subjects with a quasi-positive
(27% vs. 47% for the None – Positive treatment) and conditional behavior (23% vs.
31%). Table 16 gives statistical support for some differences among treatments for the
Public: there is a higher proportion of subjects with a negative interpretation in the
None – Negative treatment and a higher proportion of subjects with a positive
interpretation and quasi-positive behavior in the None – Positive treatment; there is no
statistical difference in the proportion of Undecided or Other behavior among
treatments. For this role it is noticeable the high levels of subjects with a quasi-positive
behavior which are also higher than those observed in the Full Information sessions.
These findings suggest that the joint impact of experience with the structure and any
adjustment process is stronger for the Public and marginal for the SRO. This is
surprising given that the Public is in disadvantage and suggests that the lack of feedback
increases their desire to search and use other forms of information to make a better
guess.
The differences in behavior of conclusions 11 and 12 are the joint result of the level of
information and the adjustment in individual behavior in none information sessions.
Conclusion 11 (PH – PL < 0 sessions): There is a difference in the behavior of the SRO
with more subjects having a Negative Interpretation in Full Information sessions than
None Information sessions. There is a difference in the composition of the Public’s
behavior with a greater proportion of subjects consistently having a negative
5
The rest may be caused by the higher demand of reasoning for the Public or confusion.
41
interpretation and a lower proportion of subjects ending the session with it in Full
Information sessions than in None Information ones.
As can be seen in the third column of Table 16 and Figure 5 there is a significantly
greater proportion of subjects having a negative interpretation as SRO in the Full –
Negative treatment (35% vs. 11% in the None – Negative treatment); there are also
more subjects with a conditional and a positive interpretation behavior in the None –
Negative treatment, however the difference is not statistically significant.
In the same column we can see that there is no significant difference in the Public’s
behavior between the Full – Negative and None – Negative treatment. However a
closer look in the composition of each form of behavior shows more subjects
consistently having a negative interpretation in the Full – Negative treatment (46% vs.
13% in the None – Negative treatment) and more subjects ending the session with a
negative interpretation in the None – Negative treatment (35% vs. 19% in the Full –
Negative treatment). These differences are statistically significant (the last one at the
10% level).6
As can be seen in the fourth column of Table 16 and Figure 5 there is a greater
proportion of subjects having a positive interpretation as SRO in the Full – Positive
treatment (72% vs. 33% in the None – Positive treatment); there are also more subjects
with a negative interpretation (15%) or undecided behavior (15%) in the None –
Positive treatment (vs. 0% for both forms of behavior in the Full – Positive treatment),
and these differences are statistically significant.
In the same column we can see a significant difference in Public’s behavior between the
Full – Positive and None – Positive treatment with more subjects having a positive
interpretation in the former (44% vs. 14% respectively). The None – Positive treatment
had also significantly more subjects with a quasi-positive behavior (47% vs. 39% in the
Full – Positive treatment) and undecided behavior (31% vs. 6%).
6
The χ2-stat for the null of equal proportions (1.d.f) for the former case is 13.85 and for the later is 3.83,
the 5% critical value is 3.84.
42
Figure 5: OBSERVED BEHAVIOR BY ROLE AND INFORMATION LEVEL
75%
Full - Neg
Full - Pos
50%
Percent
25%
0%
Negative Positive Conditional Undecided
interpretation interpretation
SRO Individual Behaviour
75%
Full - Neg
Full - Pos
50%
Percent
25%
0%
Negative Positive Quasipositive Undecided Other
interpretation interpretation
PUBLIC Strategic Behaviour
75%
None - Neg
None - Pos Mean
50%
Percent
25%
0%
Negative Positive Conditional Undecided
interpretation interpretation
SRO Strategic Behaviour
75%
None - Neg
None - Pos Mean
50%
Percent
25%
0%
Negative Positive Quasipositive Undecided Other
interpretation interpretation
PUBLIC Strategic Behaviour
43
Table 15: OBSERVED PROPORTIONS OF INDIVIDUAL BEHAVIOR BY ROLE
Don't denounce it ever: Negative Interpretation 35.4% 0.0% 14.6% 11.1% 4.2%
Always denounce it: Positive Interpretation 8.3% 72.2% 18.8% 33.3% 8.3%
PUBLIC: If the SRO denounce fraud…. / If the SRO doesn't denounce fraud….
Say "it is L" / Say anything : Negative Interpretation 64.6% 2.8% 47.9% 8.3% 37.5%
Say "it is H" / Say "it is L" : Positive Interpretation 0.0% 44.4% 0.0% 13.9% 8.3%
Say "it is H" / Say anything : Quasipositive Behaviour 18.8% 38.9% 27.1% 47.2% 33.3%
Say anything / Say anything : Undecided Behaviour 16.7% 5.6% 22.9% 30.6% 20.8%
Other: Say "it is L" / Say anything 0.0% 8.3% 2.1% 0.0% 0.0%
44
Table 16: TREATMENT COMPARISONS χ2 TESTS
FULL Neg. vs NONE Neg. vs FULL Neg. vs FULL Pos. vs NONE Pos M vs
PLAYERS STRATEGIC BEHAVIOUR BY ROLE FULL Pos. NONE Pos. M NONE Neg. NONE Pos. M NONE Pos N
SRO: If fraud is found….
Don't denounce it ever: Negative Interpretation 15.98 *** 0.22 5.99 ** 4.29 ** 0.91
Always denounce it: Positive Interpretation 36.57 *** 2.33 2.57 13.64 *** 5.03 **
Ho: The distributions of both treatments are identical 42.18 *** 2.37 7.13 * 16.74 *** 7.78 *
PUBLIC: If the SRO denounces fraud…. / If the SRO doesn't denounce fraud….
Say "it is L" / Say anything : Negative Interpretation 33.32 *** 15.08 *** 3.03 1.19 7.65 ***
Say "it is H" / Say "it is L" : Positive Interpretation 26.35 *** 7.08 *** n.a. 11.10 *** 0.43
Say "it is H" / Say anything : Quasipositive Behavior 4.19 ** 5.47 ** 0.28 0.63 1.14
Say anything / Say anything : Undecided Behavior 2.42 0.12 1.73 8.42 *** 0.70
Other: Saying anything / Saying "It is L" 4.15 ** 0.76 1.26 5.16 ** n.a.
Ho: The distributions of both treatments are identical 51.14 *** 21.56 *** 4.13 21.39 *** 7.68 *
The null hypothesis of equality is rejected at * 10% of significance ** 5% of significance *** 1% of significance n.a.: not applicable.
45
5. Summary and Conclusions
The theoretical model, based on Nuñez [], indicates that both interpretations of a fraud
exposure are possible equilibriums of the sender-receiver signaling game between the
SRO (the sender of the “message”: fraud exposure) and Consumers (the receiver of the
message, who don’t need to purchase the good from the SRO to interpret the message
thus may be actual or potential consumers or “Public”). However given the equilibrium
probability of fraud discovery for a SRO with high levels of vigilance and low levels of
fraud (PH) and for a SRO with low levels of vigilance and high levels of fraud (PL) a
Bad interpretation may emerge when PH – PL > 0 or PH – PL < 0. In the equilibrium of a
Bad interpretation the SRO will not expose fraud and if an exposure accidentally
happens the Public will attribute it to a SRO type L. A good interpretation may only
emerge when PH – PL > 0. In the equilibrium of a Good interpretation the SRO will
expose fraud and the Public will attribute any exposure to a SRO type H and any no
exposure to a SRO type L. No existent equilibrium refinement and no existent learning
model (because the Public’s severely limited capability to observe fraud and vigilance
impedes any learning from past experiences) can be applied to find a plausible outcome
for this game. Therefore we use a first empirical approach to overcome the limitations
of the theory and find how subjects behave in this situation.
We run several experimental sessions using two control variables: the sign of PH – PL
and the level of information about these probabilities. The first control variable serves
to test the relevance of the theory thus only a negative interpretation is expected when
PH – PL < 0 and either a negative or a positive interpretation may appear when PH – PL >
0. The second control variable serves to check the robustness of the theory because in a
real credence market the assumption of common knowledge about the equilibrium PH
and PL is not a plausible starting point but it should be the outcome of a long social
learning process for both the SRO and the Public that cannot be guaranteed because of
the limitation in the later. Therefore we use a “Full” level of information, i.e.
everybody knows the underlying probabilities of the game (thus at least mutual
knowledge is assured), and a “None” level of information, i.e. nobody knows these
probabilities but they exist in the underlying structure of the game (so players can learn
46
them and may adjust their behavior if they want). Previous experimental works ([], [],
[]) suggest that a meaningful context instead of a neutral context may help subjects to
understand the complexities of signaling games thus we run some sessions under a
meaningful context and the rest under a neutral context (these papers also suggest the
possibility of a weak or strong context effect depending if the meaningful context helps
to convergence or changes the behavior of individuals).
The results of the experiments put in evidence the validity of the theory as a qualitative
predictor to explain observed behavior in Full Information sessions. No strict
equilibrium was actually played when PH – PL < 0 however the tendencies in mean
behavior gives more support to a negative interpretation: a 30% of fraud exposure was
observed for the SRO and 75% of the responses when fraud was exposed favor the L
type for the Public. This is because some subjects may found the environment
unintuitive (they previously expected that an H type could find more fraud than an L
type and we tell them the opposite) and other subjects found that exposing fraud always,
never or sometimes depending on the type of the SRO was the best strategy for them.
When PH – PL > 0 no strict equilibrium was played either however the tendencies in
mean behavior strongly supports a positive interpretation: a 92% of fraud exposure
happened for the SRO, a 87% of the responses when fraud was exposed favor the H
type and 72% of the responses when fraud was not exposed favor the L type for the
Public. For this case some subjects also had a behavior conditional on the type of the
SRO and some subjects had difficulties to choose a SRO type L as their best candidate
for a no exposure in the role of Public. As the mean behavior for both signs of PH – PL
was similar in both the meaningful and neutral context sessions we have strong
evidence that solves the equilibrium indeterminacy of the theory and gives a clear
chance for the existence of reputational incentives for the SRO in the case they are
theoretically possible, i.e. when PH – PL > 0.
The use of a meaningful context instead of a neutral context was not very important for
behavior in the Full Information sessions however it really was for the None
Information sessions. If we use the Neutral context results as our benchmark to
understand behavior when no information is initially given to participants we’ll get very
bad news for the possible emergence of a good interpretation as a social learning
process and thus for the emergence of the reputational incentives for the SRO.
However if we use the Meaningful context results we’ll find more evidence that
supports a slow but continuous emergence of a good interpretation in the case it is
expected, i.e. PH – PL > 0, and of a bad interpretation in the other case. Therefore
looking at the Meaningful context sessions we find evidence that subjects are capable to
learn the underlying structure of the game and use this information to eventually adjust
their behavior in the direction observed for Full information sessions because of the
experience with the structure of the game or in reaction to others’ play.
What is also noteworthy for the None information sessions (meaningful context) is that
the joint impact of the experience with the structure and reactions to others’ play is
stronger for the Public and less for the SRO. This suggests that if the Public has the
incentives to form a correct opinion about the SRO, the lack of feedback increases their
desire to search and use other forms of information to make better guesses.
These facts have strong implications for the literature of learning in signalling games as
any lack of feedback to update beliefs may be overcome by experience and learning of
47
the crucial parameters of the game if they exist (as it is in our case). These facts also
have strong implications for the Industrial Organization of credence markets: if the
Public have somehow the opportunity to learn or credibly hear about the underlying
probabilities of fraud discovery for some levels of vigilance in the market (maybe
because this information is filtered by some of the members of the SRO) they will
certainly use this information to adjust their behavior and the market will eventually end
near a good or a bad interpretation equilibrium. Hence, the reputational incentives for
the SRO will survive as a long run outcome only in the case that a high vigilant SRO
finds fraud more times than a low vigilant SRO.
48
REFERENCES
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[8] Cooper D., Kagel J., Lo W. and Gu Q. (1999). “Games against managers in
incentive systems: Experimental results with Chinese students and Chinese
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[9] Cooper D., Garvin S. and Kagel J. (1997). “Signalling and Adaptive Learning
in an Entry Limit pricing Game”. RAND Journal of Economics, 28, pp. 662 –
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[10] Cooper D., Garvin S. and Kagel J. (1997b). “Adaptive Learning vs.
Equilibrium Refinements in an Entry Limit Pricing Game”. The Economic
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[11] Chaudhari A (1998). “The ratchet principle in a principal agent game with
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Organization, 37, pp. 291 – 304.
49
[14] De Jaegher K. (2003). “Prevention, cure, and optimal expert incentives”.
Working paper, Vrije Universiteit Brussel.
[16] Ekelund R., Mixon F. and Ressler R. (1995). “Advertising and information: an
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Research in Experimental Economics, Vol. 2, Vernon Smith ed., JAI Press.
51
APPENDIX A : INSTRUCTIONS (FULL - NEGATIVE TREATMENT)
You are participating in an academic research activity. If you follow these instructions carefully
and make good decisions you’ll win a considerable amount of money.
Keep for yourself any information given to you. If you talk during the activity you’ll be asked to
leave the room without any payment. You may ask any question when we finished to read the
instructions and filled out a questionnaire.
There is an Organization whose members deliver some service to the Public. These members may
deliver a bad service to obtain a personal benefit. Because of this the Organization watches their
members and tries to find those who deliver a bad service. Any member found delivering a bad
service receives a severe punishment.
The Organization may exert two forms of vigilance over their members: 1) She may match them
lot, or 2) She may match them few.
If she watches their members a lot most of them decide to deliver a good service to avoid a
punishment. When the Organization watches them a lot she can still find at least one member
delivering a bad service every 2 of 10 occasions she exerts her vigilance over them.
If she watches their members a few most of them decide to deliver a bad service. When the
Organization watches them a few she can still find at least one member delivering a bad service
every 8 of 10 occasions she exerts her vigilance over them.
Therefore a “Few Vigilance – Bad Service” Organization finds in more occasions at least one
member delivering a bad service than a “Lot of Vigilance – Good Service” Organization. This is
important information for this activity.
Please take a minute and watch carefully the following graphic where it’s depicted the number of
occasions at least one member is found delivering a bad service for each kind of Organization.
2 of 10
0
Lot of Vigilance - Few Vigilance -
Good Service Bad Service
52
The Public don’t know in advance what form of vigilance and service has the Organization. They
only know that she has one of the kinds with equal possibility. Because of this the Organization
communicates with the Public in the following way: she may announce or she may not announce if
any member has been found delivering a bad service.
The Public know that if the Organization found any member delivering a bad service she can
decide to announce it or she can decide not to announce it and keep silent. If the Organization
DIDN’T find any member delivering a bad service then she keeps silent because she doesn’t have
anything to announce.
The Public only sees if the Organization announces anything or keeps silent and develop an opinion
about the kind of the Organization. This opinion is highly valued by the Organization.
The rules of this activity are simple and based in the motivation you have previously read.
This activity has many rounds or repetitions. At the beginning of the activity you’ll be assigned at
random with a role which may be:
1) Public or 2) Organization
If you get the role of Public you’ll be assigned at random a kind which may be: “Lot of Vigilance –
Good Service” or “Few Vigilance – Bad Service”.
At each round seldom groups with two participants will be formed, with an “Organization” and a
“Public” in each one, as it is exemplified in the following table:
1st. phase: The Organization exerts her vigilance and finds or not finds members delivering a bad
service.
In case the Organization does find members delivering a bad service, she disposes of more and
less 20 seconds to decide if she announces it to the Public or if she doesn’t announce it and
keeps silent.
In case the Organization doesn’t find members delivering a bad service, she must keep silent; if
she doesn’t she’ll get $ 0 pesos as punishment.
53
2nd. phase: The Public observes if the Organization announces something or keeps silent and
disposes of more and less 20 seconds to make an opinion about the kind of the Organization.
The Public may choose one of the following alternatives:
a) “I am uncertain about the Organization’s kind”
b) “I think she is Lot of Vigilance – Good Service”
c) “I think she is Few Vigilance – Bad Service”
If the Public chooses the alternative b) or c) and it coincides with the true kind of the
Organization she is paired with she gets $ 2.400 pesos. If it doesn’t coincide she gets $ 0 pesos.
If she chooses the alternative a), in her place a computer will randomly choose between the
alternatives b) and c) with equal probability. She’ll get $ 2.400 if the computer chooses right or
$ 0 if it doesn’t.
This activity is anonymous therefore, you will not know the identity of the participants you’ll be
paired with at any round and only the member of your group will observe your decisions.
At each round you’ll be paired with a different participant. Every six rounds your role and the role
of the others will be reassigned at random.
When you get the role of Public it will NOT be communicated to you if your chosen alternative or
the computer’s was right or wrong at each round. You will know it only at the end of the activity.
Your payment will be calculated in the following way: at the end of the activity it will be chosen at
random one round for every six round you’ve kept a role. The amounts of money you’ve got in
those rounds will be summed and paid to you in cash. For example:
Now please put these instructions back to the folder and fill out the questionnaire inside. After that
if you have any doubt please raise your hand.
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APPENDIX B: SUMMARY (FULL – NEGATIVE TREATMENT)
2 of 10
0
Lot of Vigilance - Few Vigilance -
Good Service Bad Service
Remember that each Organization may have one of the two possible kinds with equal
possibility. At each round you will observe if the Organization marks or not marks the
announcement. At this moment you must choose one of the following alternatives:
It will not be communicated to you if your choice or the computer’s choice was right or
wrong at each round.
The PUBLIC observes if you marked the announcement or not and sends her opinion
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