Goal and Background Experimental Design Results Risk Aversion, Prospect Theory, and Strategic Risk in Law Enforcement: Evidence From an Antitrust Experiment M. Bigoni 1 S.O. Fridolfsson 2 C. Le Coq 3 G. Spagnolo 345 1 Universit` a di Padova 2 IfN, Stockholm 3 SITE, Stockholm 4 Universit` a di Tor Vergata, Roma 5 CEPR IAREP-SABE 2008 Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 1 / 31
Goal and Background Experimental Design Results Outline Goal and Background 1 Experimental Design 2 Results 3 Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 2 / 31
Goal and Background Experimental Design Results Main question: how does deterrence work? focus on organized crime Premise: organized crime as the equilibrium outcome of a repeated strategic interaction: must rely on self enforcing contracts different policies for law enforcement affect the sustainability of this equilibrium in different ways Questions: through which cognitive and behavioral “channels” does deterrence work? do agents react to law enforcement measures in a fully rational way? if not, how do behavioral departures from the standard rationality paradigm interact with the different law enforcement policies? Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 3 / 31
Goal and Background Experimental Design Results Optimal law enforcement Risk neutrality and full rationality (Becker, 1968) ⇒ the expected fine determines deterrence. increase the fine and decrease the probability of detection ⇒ minimize the cost of prosecution The idea has been recently under debate... Risk aversion (Polinsky Shavell 2000 ): optimal law enforcement is affected by the offenders’ risk attitude. Organized crime/collusion Incentive compatibility in “team crimes”: Stigler (1964) Antitrust policy adopted ⇒ affects IC constraint. Rey (2003), Motta Polo (2003) ; Spagnolo (2000, 2004) ; Harrington (2008) Higer strategic risk reduces trust, hence collusion: Spagnolo (2004), Blonski et al. (2004, 2007) ) higher strategic risk if leniency is granted to the whistleblowers; higher absolute fines increase strategic risk under leniency. Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 4 / 31
Goal and Background Experimental Design Results Optimal law enforcement Risk neutrality and full rationality (Becker, 1968) ⇒ the expected fine determines deterrence. increase the fine and decrease the probability of detection ⇒ minimize the cost of prosecution The idea has been recently under debate... Risk aversion (Polinsky Shavell 2000 ): optimal law enforcement is affected by the offenders’ risk attitude. Organized crime/collusion Incentive compatibility in “team crimes”: Stigler (1964) Antitrust policy adopted ⇒ affects IC constraint. Rey (2003), Motta Polo (2003) ; Spagnolo (2000, 2004) ; Harrington (2008) Higer strategic risk reduces trust, hence collusion: Spagnolo (2004), Blonski et al. (2004, 2007) ) higher strategic risk if leniency is granted to the whistleblowers; higher absolute fines increase strategic risk under leniency. Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 4 / 31
Goal and Background Experimental Design Results Behavioral Law and Economics Law enforcement creates incentives to obey the rules understanding how agents react to incentives is essential to make them more effective: Frey and Jegen (2001); Fehr and Falk (2002); Gneezy and Rustichini (2004) A recent stream of works has applied behavioral insights from psychology to law and economics (Jolls, Sustein and Thaler 1998 ; Jolls 2007 ): Bounded rationality (endowment effect, loss-aversion, overoptimism, availability heuristic, self-serving bias, ...) Bounded willpower (myopia, hyperbolic discounting...) Bounded self-interest (other regarding preferences, fairness...) affect the way people react to legal prescriptions ⇒ optimal law enforcement. Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 5 / 31
Goal and Background Experimental Design Results Behavioral Law and Economics Law enforcement creates incentives to obey the rules understanding how agents react to incentives is essential to make them more effective: Frey and Jegen (2001); Fehr and Falk (2002); Gneezy and Rustichini (2004) A recent stream of works has applied behavioral insights from psychology to law and economics (Jolls, Sustein and Thaler 1998 ; Jolls 2007 ): Bounded rationality (endowment effect, loss-aversion, overoptimism, availability heuristic, self-serving bias, ...) Bounded willpower (myopia, hyperbolic discounting...) Bounded self-interest (other regarding preferences, fairness...) affect the way people react to legal prescriptions ⇒ optimal law enforcement. Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 5 / 31
Goal and Background Experimental Design Results Factors in risk perception Disregarding/overweighting small probabilities (Kahneman Tversky 1979 ): “Highly unlikely events are either ignored or overweighted, and the difference between high probability and certainty is either neglected or exaggerated.” Availability heuristic and salience of punishments (Tversky Kahneman 1982; Akerlof 1991; Slovic et al. 2004 ; Keller et al. 2006) punishment experienced in past periods may be associated with negative affect that might increase the level of risks perceived stronger affect as the fine gets larger or as detection becomes more frequent. Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 6 / 31
Goal and Background Experimental Design Results Factors in risk perception Disregarding/overweighting small probabilities (Kahneman Tversky 1979 ): “Highly unlikely events are either ignored or overweighted, and the difference between high probability and certainty is either neglected or exaggerated.” Availability heuristic and salience of punishments (Tversky Kahneman 1982; Akerlof 1991; Slovic et al. 2004 ; Keller et al. 2006) punishment experienced in past periods may be associated with negative affect that might increase the level of risks perceived stronger affect as the fine gets larger or as detection becomes more frequent. Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 6 / 31
Goal and Background Experimental Design Results Behavioral Interaction between Risk and Trust Organized crime requires trust among members of the criminal organization. Experimental evidence (trust game) on the relation between risk attitudes and trust is mixed: risk averse players less trustful : Karlan (2005),Sapienza et al. (2007),Schechter (2007) no significant relation : Eckel and Wilson (2004), Ashraf et al. (2006) Bohnet and Zeckhauser (2004): individuals more willing to take risks when the outcome is due to chance than when it depends on whether another player proves trustworthy ⇒ betrayal aversion . Organized crime is a more complex game: “external” risk of being detected and sanctioned “internal” risk of being betrayed Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 7 / 31
Goal and Background Experimental Design Results Behavioral Interaction between Risk and Trust Organized crime requires trust among members of the criminal organization. Experimental evidence (trust game) on the relation between risk attitudes and trust is mixed: risk averse players less trustful : Karlan (2005),Sapienza et al. (2007),Schechter (2007) no significant relation : Eckel and Wilson (2004), Ashraf et al. (2006) Bohnet and Zeckhauser (2004): individuals more willing to take risks when the outcome is due to chance than when it depends on whether another player proves trustworthy ⇒ betrayal aversion . Organized crime is a more complex game: “external” risk of being detected and sanctioned “internal” risk of being betrayed Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 7 / 31
Goal and Background Experimental Design Results Behavioral Interaction between Risk and Trust Organized crime requires trust among members of the criminal organization. Experimental evidence (trust game) on the relation between risk attitudes and trust is mixed: risk averse players less trustful : Karlan (2005),Sapienza et al. (2007),Schechter (2007) no significant relation : Eckel and Wilson (2004), Ashraf et al. (2006) Bohnet and Zeckhauser (2004): individuals more willing to take risks when the outcome is due to chance than when it depends on whether another player proves trustworthy ⇒ betrayal aversion . Organized crime is a more complex game: “external” risk of being detected and sanctioned “internal” risk of being betrayed Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 7 / 31
Goal and Background Experimental Design Results What we did Ran a series on explicit collusion in oligopoly Results also relevant for other forms of corporate crime, corruption, financial fraud, etc. Simulated a repeated oligopoly in the lab , and embedded it in different law enforcement environments: Absence of enforcement: collusion is allowed “traditional” antitrust law enforcement policies Leniency programs Looked at how deterrence varies under these alternative policies depending also on: subjects degree of risk aversion size of fines and probability of detection players’ experiences in previous rounds Presenter: M. Bigoni (Univ. Padova) Deterrence of Organized Crime IAREP-SABE 2008 8 / 31
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