Contributions published at Microeconomics (Nick Netzer)

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We introduce intention-based social preferences into a mechanism design framework with independent private values and quasilinear payoffs. For the case where the designer has no information about the intensity of social preferences, we provide conditions under which mechanisms which have been designed under the assumption that agents are selfish can still be implemented. For the case where precise information about social preferences is available, we show that any tension between efficiency, incentive-compatibility, and voluntary participation may disappear. Impossibility results such as the one by Myerson and Satterthwaite (1983) are then turned into possibility results. We also provide a systematic account of the welfare implications of kindness sensations.

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A strategy profile of a game is called robustly stochastically stable if it is stochastically stable for a given behavioral model independently of the specification of revision opportunities and tie-breaking assumptions in the dynamics. We provide a simple radius-coradius result for robust stochastic stability and examine several applications. For the logit-response dynamics, the selection of potential maximizers is robust for the subclass of supermodular symmetric binary-action games. For the mistakes model, the weaker property of strategic complementarity suffices for robustness in this class of games. We also investigate the robustness of the selection of risk-dominant strategies in coordination games under best-reply and the selection of Walrasian strategies in aggregative games under imitation.

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An auction is said to be externality-robust if unilateral deviations from equilibrium leave the remaining bidders’ payoffs unaffected. The equilibrium and its outcome will then persist even if externalities between bidders arise from certain types of interdependent preferences. One important example are externalities due to spiteful preferences, which are frequently used to explain overbidding in auctions. Another important example are cross-shareholdings between firms that compete in an auction. For the independent private values model, we derive an auction that coincides with the second-price auction (SPA) in terms of efficiency and expected revenue, and, in contrast to the second-price auction, is also externality-robust. The externality-robust auction (ERA) is a first-price auction in which truthful bidding is encouraged by bonus payments. We test the robustness property experimentally by comparing the outcomes of the SPA and the ERA. We replicate the earlier finding of significant average overbidding in the SPA, while we find no overbidding on average in the ERA. We also conduct additional treatments where bidders play against the computer, and we use controls for cognitive skills and joy of winning to further pin down the reasons behind the subjects’ bidding behavior and to understand the sources of individual heterogeneity.

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We construct a fully specified extensive form game that aptures competitive markets with adverse selection. In articular, it allows firms to offer any finite set of contracts, so that cross-subsidization is not ruled out. Moreover, firms can withdraw from the market after initial contract offers have been observed. We show that a subgame perfect equilibrium always exists and that, in fact, when withdrawal is costless, the set of subgame perfect equilibrium outcomes may correspond to the entire set of feasible contracts. We then focus on robust equilibria that exist both when withdrawal costs are zero and when they are arbitrarily small but strictly positive. We show that the Miyazaki-Wilson contracts are the unique robust equilibrium outcome of our game. This outcome is always constrained efficient and involves cross-subsidization from low to high risk agents that is increasing in the share of low risks in the population under weak conditions on risk preferences.

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We examine a “Rotten Kid” model (Becker 1974) where a player with social preferences interacts with an egoistic player. We assume that social preferences are intentionbased rather than outcome-based. In a very general multi-stage setting we show that any equilibrium must involve mutually unkind behavior of both players, endogenously generating negative rather than positive emotions. In a large class of two-stage games that includes principal-agent and gift-giving games, this prevents the equilibrium from being materially Pareto efficient. Compared to the subgame-perfect equilibrium without social preferences, efficiency is still generally increased. On the other hand, the materialistic player has lower whereas the reciprocal player has higher material payoffs, so that reciprocity does not increase equity: For sufficiently strong reciprocity concerns, the materialistic player ends up with a negligible share of the gains from trade.

The economic concept of the second-best involves the idea that multiple simultaneous deviations from a hypothetical first-best optimum may be optimal once the first-best itself can no longer be achieved, since one distortion may partially compensate for another. Within an evolutionary framework, we translate this concept to behavior under uncertainty. We argue that the two main components of prospect theory, the value function and the probability weighting function, are complements in the second-best sense. Previous work has shown that an adaptive S-shaped value function may be evolutionary optimal if decision-making is subject to cognitive or perceptive constraints. We show that distortions in the way probabilities are perceived can further enhance fitness. The second-best optimum involves overweighting of small and underweighting of large probabilities. Behavior as described by prospect theory might therefore be evolution's second-best solution to the fitness maximization problem. We discuss under which circumstance our model makes empirically testable predictions about the relation between individuals' value and probability weighting functions.

In the presence of a time-inconsistency problem with agency contracts, we show that competitive markets can implement allocations that Pareto-dominate those achieved by a benevolent government, and they induce more effort. We analyze a model with moral hazard and a two-sided lack of commitment. After agents have chosen their work, firms can modify contracts and agents can switch firms. If the ex post market outcome satisfies a weak notion of competitiveness and sufficiently separates individuals, it is Pareto superior to a government’s allocation with a complete breakdown of incentives. Moreover, competitive markets without commitment implement more effort in equilibrium under general conditions.