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1 Americn Poliicl Science Review Vol. 95, No. 1 Mrch 2001 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding IRIS BOHNET Hrvrd Universiy BRUNO S. FREY Universiy of Zürich STEFFEN HUCK Universiy of London Mos conrcs, wheher beween voers nd poliicins or beween house owners nd conrcors, re incomplee. More lw, i ypiclly is ssumed, increses he likelihood of conrc performnce by incresing he probbiliy of enforcemen nd/or he cos of brech. We exmine conrcul relionship in which he firs mover hs o decide wheher she wns o ener conrc wihou knowing wheher he second mover will perform. We nlyze how conrc enforcebiliy ffecs individul performnce for exogenous preferences. Then we pply dynmic model of preference dpion nd find h economic incenives hve nonmonoonic effec on behvior. Individuls perform conrc when enforcemen is srong or wek bu no wih medium enforcemen probbiliies: Trusworhiness is crowded in wih wek nd crowded ou wih medium enforcemen. In lborory experimen we es our model s implicions nd find suppor for he crowding predicion. Our finding is in line wih he recen work on he role of conrc enforcemen nd rus in formerly Communis counries. Trus cn increse efficiency in he economic nd poliicl spheres. Recen sudies using ggrege d sugges he exisence of n efficiency-enhncing feure of rus for counries nd orgnizions. 1 We emp o provide microfoundion for some of hese findings by invesiging wheher rusworhiness cn hve n economic pyoff he individul level. Imporn domins for rus nd rusworhiness include he relionship beween represenives nd heir consiuens, such s beween poliicins nd voers, mngers nd shreholders, or orneys nd cliens. In ll hese siuions, principls hve o decide wheher hey wn o ener conrc h hey know will be incomplee (i.e., gens migh hve n incenive Iris Bohne is Assisn Professor of Public Policy, Kennedy School of Governmen, Hrvrd Universiy, Cmbridge, MA Bruno S. Frey is Professor of Economics, Insiue for Empiricl Economic Reserch, Universiy of Zürich, Bluemlislpsree 10, 8006 Zürich, Swizerlnd ch). Seffen Huck is Senior Lecurer in Economics, Deprmen of Economics, Royl Hollowy College, Universiy of London, Eghm, Surry TW20 0EX, Unied Kingdom The uhors hnk Lind Bbcock, Sm Bowles, Uwe Dulleck, Erns Fehr, Simon Gächer, Werner Güh, Ernn Hruvy, Owen Jones, Michel Mndler, Jörg Oechssler, Elinor Osrom, Fred Schuer, Richrd Zeckhuser, nd hree nonymous referees, s well s pricipns of he 1998 Americn Lw nd Economics Associion meeings Berkeley, he 1999 Economic Science Associion meeings Lke Thoe, he 1999 Symposium on Behviorl Economics he Levy Insiue, he 1999 SPUDM meeings in Mnnheim, he 2000 Public Choice Associion meeings in Chrleson, he 2000 meeing of he McArhur Foundion Nework on Economic Environmens nd he Evoluion of Individul Preferences nd Socil Norms in Chicgo, nd seminrs Hrvrd, Royl Hollowy, nd he Universiy of Zürich for mny helpful commens nd suggesions. Furher hnks re due o Dorohe Kübler for her help in conducing he experimens, o Jonn Velri for her edioril suppor, nd o Michel Zürcher for his legl dvice. Finncil suppor of he Germn nd he Swiss Nionl Science Foundion, he Kennedy School of Governmen Den s Fund, nd he Russell Sge Foundion re grefully cknowledged. 1 See, for exmple, Fukuym 1995; Knck nd Keefer 1997; L Por e l. 1997; or Punm o brech). Offering he conrc is mer of rus, nd performing i, mer of rusworhiness. The problem of rus is more pronounced in lrge, nonymous socieies hn in smll groups. In he ler cse, pricipns frequenly inerc, nd repuion mers. Therefore, ccording o he folk heorem ype of rgumen, cooperion cn be susined even in he bsence of genuine rusworhiness. 2 This kind of rgumen fils in he cse of lrge groups, nd insiuions such s he lw re needed o fcilie efficien oucomes. 3 The lw, however, my ffec behvior no only by creing incenives bu lso by influencing preferences. Wheres rionl choice heory focuses on he firs spec, we propose model h inegres boh. We nlyze how he enforcebiliy of conrc ffecs individul performnce in he shor run wih given preferences nd in he long run when preferences dp o he new environmen. Our nlysis builds on n evoluionry pproch. 4 We presen nlyicl resuls nd es heir implicions in lborory experimen. A conrcul relionship is represened by gme in which he firs mover hs o decide wheher she wns o ener conrc wihou knowing wheher he second mover will perform. If he second mover breches, chnce move decides wheher he is held lible for he cos of brech. Sndrd economic nlysis of lw predics h he higher he expeced cos of brech, he more likely is he second mover o perform. 2 Folk heorems sy h in infiniely repeed gmes ny fesible pyoff combinion cn be suppored by n equilibrium. 3 See, for exmple, Greif, Milgrom, nd Weings 1994 nd Milgrom, Norh, nd Weings For proof of he folk heorem in he prisoner s dilemm wih lrge groups nd nonymous inercion, see Ellison The behviorl relevnce of repeiion nd nonymiy hve been sudied in mny lborory experimens, e.g., Andreoni 1988 nd Bohne nd Frey For survey, see Osrom 1998, who lso discusses how experimenl resuls rele o poliicl science. 4 See, for exmple, Axelrod 1984; Becker 1976; Bendor nd Swisk 1997; Bowles 1998; Boyd nd Richerson 1985; or Güh nd Kliem

2 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding Mrch 2001 We show h, when preferences re subjec o chnge, his need no be he cse. More specificlly, we find h he probbiliy wih which conrc is enforced hs nonmonoonic effec on behvior: Performnce res of second movers re high no only when he expeced cos of brech is sufficienly lrge bu lso when i is sufficienly smll. We focus on preferences for conrc performnce nd ssume h individuls my experience psychologicl coss when hey brech. Such rusworhy people re sid o hve preference for honesy. 5 Bsed on he ide h specific preference is more likely o be minined nd o flourish if i proves o be economiclly successful, we sudy dynmic process in which preferences cn chnge over ime. Legl rules cn crowd in s well s crowd ou preferences. We find h inermedie levels of conrc enforcemen led o crowding ou, bu low levels induce crowding in. The inuiion for his is rher srighforwrd. Suppose firs mover mus decide wheher o ener conrc. If she knows h he legl sysem is inefficien, h is, conrcs re rrely enforced, she will be exremely cuious. Clerly, she would like o ener if she knew he oher pry could be rused. If signl is received bou he prner s rusworhiness, i mus be sufficienly good. This cuion no only proecs firs movers from being exploied oo ofen bu lso mkes rusworhy second movers more successful hn ohers, becuse on verge hey will ge more conrcs hn ohers. Hence, honesy will be crowded in. Conrcul relionships wih wek enforcemen re ypicl in mny orgnizionl seings. Some firms purposely cree low enforcemen environmen in which inercions re no guided by he expeced cos of brech bu by inrinsic moivion. A he sme ime, hey hevily inves in screening of poenil employees, sressing h chrcer is more imporn hn he possession of specific skills. 6 Similrly, mos microfinnce insiuions (e.g., Grmeen Bnk or Accion) h lend money o poor cliens wihou physicl collerl focus on chrcer-bsed lending. In he bsence of exernl enforcemen mechnisms, he inrinsic rusworhiness of cliens is key vrible h mkes he conrc beween borrower nd lender possible (Murdoch 1999). The sme pern pplies o mny oher domins: The more leewy gens hve wheher hese re employees, borrowers, legislors, judges, or execuives he more creful re principls when deciding who will be offered conrc. Th he leewy for poliicins cn be considerble becomes cler in Rose- Ackermn s (1999) nlysis of corrupion. She poins ou h even in he Unied Ses he lw is no sric 5 We re purposely vgue here for wo resons. Our model does no depend on he specifics of he psychologicl coss incurred nd our experimen does no es for differen kinds of such coss. Our resuls re compible wih inrinsic moivion (see, e.g., Frey 1997), inequliy version (see, e.g., Bolon nd Ockenfels 2000 or Fehr nd Schmid 1999), reciprociy (see, e.g., Rbin 1993), nd psychologicl conrcs (see, e.g., Rousseu 1995). 6 For summry of such high-commimen humn resource mngemen prcices, see Bron nd Kreps enough o deer eleced officils from being corrup. The criminl penlies re no more hn hree imes he monery equivlen of he hing in vlue (i.e., he bribe) or imprisonmen for no more hn fifeen yers, or boh (18 USC 201 ()). This is pproprie for officils who receive bribes excep h muliplying by hree my be poor mesure of he risk of deecion nd punishmen. The cul probbiliy of cch is likely o be well below one-hird (p. 55). Wheher his probbiliy is low enough o induce crowding-in is n empiricl quesion. If he probbiliy of conrc enforcemen is higher bu no high enough o deer ll second movers from breching, hen we expec crowding-ou. Under medium enforcemen, he expeced pyoff of enering is higher hn he pyoff of bsining, even if he firs mover knows h he conrc will be breched. Accordingly, she will ener regrdless of her beliefs bou he prner s rusworhiness. This uncondiionl rus mkes second movers who wn o mximize expeced monery pyoffs more successful hn hones ypes who forske profible opporuniies o brech. Therefore, honesy will be crowded ou, cusing he foresid nonmonooniciy. In sum, under high levels of enforcemen, ll second movers perform becuse hey re deerred regrdless of heir preferences, nd ll firs movers ener he conrc; preferences re irrelevn nd oucomes re efficien. A inermedie levels, honesy is crowded ou; more second movers brech, nd resources re wsed in rils. A low levels, rusworhiness is crowded in; more second movers perform even hough hey would hve n incenive o brech wihou preference for honesy, nd efficiency increses. Conrc enforcemen probbiliies h re oo smll o deer brech my be due o bdly funcioning legl sysem wih wek se proecion, corrup governmens nd judiciries, or high enforcemen coss. So fr, he lierure hs focused minly on how informl insiuions, such s socil norms, my subsiue for n ineffecive legl sysem nd wheher shme nd osrcism cn replce imprisonmen nd fines. 7 Our model focuses on forml lw nd inrinsic disposiions nd shows how he effeciveness of ech depends on he oher. By providing specific legl enforcemen regime, he se ffecs he degree of rus nd rusworhiness in sociey. By including forml insiuions in he nlysis we ddress n spec rrely exmined in he curren debe on rus nd socil cpil. 8 7 Socil norms confine minor crimes, such s respssing (Ellickson 1991), or he overuse of common pool resources (Osrom, Grdner, nd Wlker 1994). For he legl debe bou lernive sncions see Khn 1996, nd for generl discussion of how socil norms nd he lw inerc, see Cooer 1998 or Sunsein Trrow (1996, 395) sks: Cn we be sisfied inerpreing civic cpciy s home-grown produc in which he se hs plyed no role? Schneider e l. (1997) re mong he few who discuss he influence of insiuions, nmely, he exen o which prens cn choose public school, on socil cpil. Those ineresed in his influence minly focus on he relionship beween insiuions nd rus rher hn beween insiuions nd rusworhiness (see, e.g., Brehm nd Rhn 1997; Norris 1999; nd Nye, Zelikow, nd King 1997). 132

3 Americn Poliicl Science Review Vol. 95, No. 1 Our findings my help undersnd wo endencies observed in mny counries of he former Sovie block. On he one hnd, here is demnd for more lw in order o enforce conrcs nd secure propery righs. When he se cnno provide levels of enforcemen high enough o deer brech, he demnd for proecion is sisfied prively. This is one explnion for he rise of he Mfi in Sicily (Gmbe 1993) nd my ccoun for is hriving in Russi (Vrese 1994). On he oher hnd, reemergence of he demnd for nd supply of rus-bsed relionships cn be observed in he very sme counries. Winrobe (1995, 46 7) wries: The bsence of enforcebiliy generes demnd for rus. The coss of rus formion re lower, when he wo pries shre common ris, such s common lnguge, ehniciy, nd so on. His nlysis differs from ours, bu his conclusions re similr: More order cn be chieved by relying on rus-bsed relionships when ech pry cn predic he oher s likelihood of cooperion. We sugges rionle for he coexisence of hese wo endencies. If rusworhiness hs been crowded ou, people cnno help sking for more lw, nd if i hs been crowded in, hey cn rely on rus-bsed inercions. According o Simis (1982) nd Vrese (1994), he former Sovie sysem ws chrcerized by corrupion ffecing only specific secions of he populion, nmely, he nomenclur. In he bsence of credible se, hese groups re unble o engge in rus-bsed inercions nd, hus, demnd prive proecion. For ordinry people, rus ws nd remins he bsis of heir conrcul relionships (Winrobe 1995). Overll, our model predics pern encpsuled in Lin Americn quip: For friends everyhing, for enemies nohing, for he srnger he lw. 9 The model s empiricl vlidiy is esed in lborory experimen h implemens he heoreicl seup s closely s possible, nd he resuls suppor he crowding predicions. The ricle is orgnized s follows. We firs describe how gens behve wih fixed preferences. Nex, we nlyze he crowding dynmics nd discuss he model s min implicions. We hen presen he design nd he experimenl resuls. In he finl secion we offer conclusions. THEORY The Conrc Gme We model siuion in which wo plyers hve he opporuniy o produce join surplus, bu he plyers re symmericl. Plyer 1 hs o ener he conrc wihou knowing wheher plyer 2 will perform. Therefore, plyer 1 s decision o ener is mer of rus A los migos odo, los enimigos nd, l exrño l ley (Rose-Ackermn 1999, 97). 10 For reled gmes on rus, see Berg, Dickhu, nd McCbe 1995; Burnhm, McCbe, nd Smih 1999; Gleser e l. 2000; Güh nd Kliem 1999; or Vn Huyck, Blio, nd Wlers We denoe her rusing move wih T nd her nonrusing move wih T. In he cse where she russ, plyer 2 cn perform (move P) or brech (P ). The gme ends eiher if plyer 1 does no ener, which yields zero pyoffs for boh pries, or if plyer 1 s rus is rewrded by plyer 2 s cooperion. This yields pyoffs of 1 for boh plyers. 11 If plyer 2 breches, we ssume finl chnce move h cpures liigion process, wih probbiliy p h 2 will be held lible (move L). The surplus is divided, s in he cse of performnce, bu he loser hs o ber he coss of he ril c 0. In oher words, we ssume h perfec expecion dmges plce plyer 1 in he posiion in which she would hve been if plyer 2 hd performed nd h ll legl fees re pid by plyer 2, he loser. 12 Thus, he pyoffs re 1 for plyer 1 nd 1 c for plyer 2. If plyer 2 is no held lible (L ), he profis from brech nd receives pyoff of 1 b (wih b 0); plyer 1 bers he legl cos nd is no compensed for ny invesmens she mde by enering he conrc, so her pyoff is wih c. Brech is never efficien. The benefis from i re no lrge enough o compense he firs mover, h is, b 1. Figure 1 shows his gme in is exensive form. We ssume h ll pyoffs re monery, bu in order o solve he gme we need uiliies ssocied wih he vrious oucomes. To mp oucomes ino (crdinl) uiliies, we ssume wo possible preferences for plyers. One ype of plyer (M) is only ineresed in (expeced) monery pyoffs, so for his ype he monery pyoffs in Figure 1 represen uiliies. The second ype of plyer (H) hs preference for honesy nd suffers psychologicl cos when breching conrc. These coss re so high h H ypes will never bery regrdless of he monery gin b. 13 Wih his se of possible preferences {M, H}, we cn rnsform he money gme of Figure 1 ino sndrd gme in which he pyoffs re von Neumnn- Morgensern uiliies. This is done by replcing he pyoff of plyer 2 fer ph TPL by 1 b, where 0 for ype M, nd b for ype H. Assuming h plyer 1 recognizes wheher plyer 2 is M or H, we hve, for ech possible mch of plyers, well-specified sndrd gme. 14 We solve his gme 11 This specificion of he pyoffs is simple normlizion wihou loss of generliy. 12 This corresponds o he English legl cos llocion rule. 13 This ssumpion simplifies he nlysis wihou lering he resuls, ll of which would sill hold if we llowed differen levels of psychologicl cos. Noice h in he cse of coninuous spce possibly rnging from infinie (psychologicl) coss o infinie gins ll h mers is wheher he coss re lrger or smller hn he monery gin b. 14 If plyer 2 is ype M, he gme is idenicl o h shown in Figure 1. If plyer 2 is ype H, he pyoff fer ph TPL is 1 b 1 b. 133

4 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding Mrch 2001 FIGURE 1. The Conrc Gme wih Monery Pyoffs Noe: Plyer 1 chooses beween T (her rusing move) nd T (her nonrusing move). Afer T, plyer 2 chooses beween P(erformnce) nd nonperformnce (P). Afer P, chnce decides wheher plyer 2 is held L(ible) or no (L). The end nodes show he wo plyers respecive pyoffs. by bckwrd inducion. 15 Obviously, plyer 2 will brech if his expeced pyoff exceeds 1, h is, if p 1 c 1 p 1 b 1. (1) For ype H his is never fulfilled, becuse plyer 2 wih preference for honesy will lwys choose P. For ype M, we cn inser 0 ino inequliy 1 nd rewrie i s b b c. (2) Plyer 2 of ype M breches if he probbiliy of enforcemen is smller hn he benefi of brech divided by he benefi plus he legl cos. Nex, consider he decision of plyer 1. If she is confroned wih n H ype, she will surely rus. The sme is rue if she is confroned wih n M ype nd 15 Admiedly, he ssumpion of perfec ype recogniion is srong, bu he resuls hold s long s plyers receive sufficienly informive signls bou he opponen s ype. This is lso discussed ler nd illusred in Appendix A. The min effec of ssuming perfec signls is h i simplifies noion nd nlysis significnly. Recen experimenl evidence suppors he noion h ype recogniion is possible fer preply communicion in prisoner s dilemm gme (Frnk, Gilovich, nd Regn 1993; Orbell nd Dwes 1991). Kikuchi, Wnbe, nd Ymgishi (1995) found h rusworhy ypes re beer predicing ohers ypes hn re nonrusworhy ypes. More generlly, see Frnk b b c holds. Bu if she is confroned wih n M ype nd (2) is fulfilled, she will ener only if her expeced pyoff exceeds her ouside-opion pyoff, h is, if (1 p) 0. This cn be rerrnged s 1. (3) From his proposiion follows. PROPOSITION 1. The (unique) subgme perfec equilibrium (SPE) is (T,P) if plyer 2 is of ype H or if plyer 2isofypeMnd b b c ; his is he high-probbiliy regime [High p]; (T,P) if plyer 2 is of ype M nd 1 b b c, clled he medium-probbiliy regime [Medium p]; nd (T, P) if plyer 2 is of ype M nd 134

5 Americn Poliicl Science Review Vol. 95, No. 1 min 1, b b c, he low-probbiliy reigme [Low p]. We shll ssume below h c b. Oherwise (T,P) would never be n SPE, nd he crowding nlysis would be less rich nd less ineresing. Imposing his requiremen mens, informlly speking, h he loss plyer 1 incurs from uncompensed beryl mus be relively smll in comprison o he profi of plyer 2 nd he legl coss. Crowding We hve shown how individuls wih given preferences behve under differen legl regimes, nd we now llow for preferences o dp o he conrcul siuion. This enbles us o sudy he implicions of preference crowding for our model. Economiclly successful preferences re crowded in, nd unsuccessful preferences re crowded ou. Formlly, he shre of ypes wih cerin preference grows fser hn noher shre if nd only if he verge meril ernings of he former exceed he verge ernings of he ler. In he conex of our model nd in he bsence of fully fledged heory of preference formion, his ssumpion seems resonble. Conrcs re closed o secure meril benefis, nd he oucomes of our conrc gme re exclusively chrcerized by differen resource llocions. 16 The ssumpion h successful ris spred is ofen ssocied wih models of geneic evoluion, lhough i cn be jusified differenly. 17 One jusificion is offered in Appendix B, which briefly illusres sochsic model of individul preference dpion. 18 In our model, his implies he following: If honesy leds o forsking profible opporuniies such h ypicl H erns less hn ypicl M, honesy will be crowded ou. If n environmen fvors honesy, such h, on verge, H ypes ern more hn M ypes, honesy will be crowded in. In order o clcule he success of he wo differen 16 Oher sudies nlyze endogenous preferences in similr frmework (e.g., Beser nd Güh 1998; Huck nd Oechssler 1999; To 1999), especilly Güh nd Kliem 1999, who lso del wih he issue of rus. Pioneering sudies suggesing h endogenous preferences my resul from pyoff-driven (evoluionry) dynmics re Becker 1976 nd Hirshleifer We do no wish o generlize oo much, however, s differen mechnisms my pply if one dels wih iudes owrd drugs, religion, or oher domins in which oucomes re less ngible. For survey of lernive pproches, see Bowles For wo such jusificions, see Börgers nd Srin 1997 nd Schlg We ssume h he probbiliies wih which preferences re dped depend on wo fcors, economic success nd conformiy. The more n individul s environmen fvors cerin preference nd he more common is cerin preference, he more likely is n individul o develop he sme preference. (Noe, however, h dpion is no delibere. People cnno consciously decide bou heir preferences. For differen pproch, see Cooer 1998.) We show h his process behves, under cerin ddiionl regulriy ssumpions, like growh-monoonic (evoluionry) process. ypes (of preferences), we ssume rndom mch of plyers nd enough individuls o ensure h he lw of lrge numbers cn be pplied. This llows us o ke expeced vlues s mesure of success. Proposiion 1 shows h wh hppens when wo plyers inerc depends on he vlue of p, he probbiliy h he conrc is enforced. The proposiion disinguishes hree regimes, nd in ech cse we cn show how preferences re crowded in nd ou. In he high-probbiliy regime, b b c, ll individuls, regrdless of ype nd mching, will ply he SPE (T,P). Plyers of boh ypes receive he sme expeced monery pyoff, so here will be no crowding. Regrdless of he numbers of H nd M ypes, he high enforcemen probbiliy ensures performnce. In he medium-probbiliy regime, 1 b b c, behvior in mch depends on he ype of plyer 2. If plyer 2 is n H, he SPE is (T,P). If he is n M, he SPE is (T,P). Since M mximizes expeced monery pyoffs bu H does no, i follows h verge ernings of M ypes exceed hose of H ypes. In he role of plyer 2, M ypes ern on verge p(1 c) (1 p)(1 b), which is sricly greer hn 1, he pyoff of n H ype in he role of plyer 2. In he role of plyer 1, boh ypes do eqully well on verge, since he expeced pyoff of plyer 1 is independen of her ype. Thus, wih medium p, M ypes lwys ern more hn H ypes (regrdless of heir number). Accordingly, hones preferences will be crowded ou. This implies, sympoiclly for he long run, h H ypes will compleely vnish nd h ll individuls will ply equilibrium (T,P). In he low-probbiliy regime, 1, we ke ino ccoun h he SPE is (T,P) if plyer 2 is n M nd (T,P) if plyer 2 is n H. In his cse, he ernings of H ypes exceed he ernings of M ypes. In he role of plyer 2, n H lwys receives 1, n M lwys 0. In he role of plyer 1, he verge pyoffs of boh ypes re gin idenicl. They do no depend on heir own ype. Thus, wih low p, preferences for honesy re crowded in nd, in he long run, ype M will vnish, such h ll individuls will ply he rus-rewrding equilibrium (T,P). We summrize our resuls in he following proposiion. PROPOSITION 2. In he high-probbiliy regime, where b b c, here is no crowding; in he long run boh ypes my be presen in he sociey, nd ll individuls ply (T,P). 135

6 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding Mrch 2001 In he medium-probbiliy regime, where 1 b b c, rusworhiness is crowded ou; in he long run only ype M will be presen in he sociey, nd ll individuls ply (T,P). In he low-probbiliy regime, where 1, rusworhiness is crowded in; in he long run only ype H will be presen in he sociey, nd ll individuls ply (T,P). The long-run sble ses lso cn be derived by nlyzing evoluionry gmes in which he wo ypes compee. For b b c his gme is rivil, becuse boh ypes behve ideniclly nd receive idenicl pyoffs. For he oher cses, he wo mrix gmes in bles 1 nd 2 emerge. (Noe h he pyoffs re bsed on he ssumpion h boh ypes re eqully likely o become plyer 1 or 2). As b b c, i is esy o see h he gme hs unique evoluionry sble sregy (see Mynrd Smih 1982). There is unique equilibrium (M,M), nd he equilibrium is sric. Hence, he unique evoluionry sble sregy is M. This mirrors he second resul of proposiion 2: In he long run only M ypes survive. An even simpler mrix emerges in he low-probbiliy regime, where 1. Clerly, he unique equilibrium of his gme is (H,H); becuse he equilibrium is sric, he unique evoluionry sble sregy is H. This mirrors he hird resul of proposiion 2. TABLE 1. The Evoluionry Gme wih Medium Probbiliy p 1 b b c Type M Type H Type M 1 b p(1 b c) 2 b p(b c) Type H 1 p(1 ) 2 TABLE 2. The Evoluionry Gme wih Low Probbiliy p 1 Type M Type H Type M 0 1 Type H 1 2 Discussion There re wo min implicions of proposiion 2. The mos fundmenl one is h i is impossible o predic behvior in group of gens plying he conrc gme wihou knowing heir hisory. Individul preferences re subjec o chnge, nd oucomes in one round ffec he disribuion of ypes in he nex. And becuse preferences depend on ps regimes, so do cions. The longer group plys in low-probbiliy environmen, he more gens wih preference for honesy re presen, nd he less brech is observed. The opposie is rue for medium-probbiliy environmen. Also, i my be possible h groups hve experienced regime chnges in he ps, in which cse one needs o know no only how long he group hs been plying under he curren regime bu lso how long under he preceding one. The ol crowding hisory mers. The second significn implicion is h he probbiliy of conrc enforcemen exers nonmonoonic effec on behvior, which would no occur in sndrd models wih fixed preferences. 19 The wors legl regime is no one in which conrcs cnno be enforced bu one wih n inermedie level of enforcebiliy. Wih n inermedie p, firs movers do no cre wih whom hey inerc, becuse enering he conrc is beer hn sying ouside, even if he conrc is breched. This lck of cuion mkes dishones second movers economiclly successful, so he shre of dishones ypes will grow. There re hen wo lernives: more order wih more lw or more order wih less lw. Wih less lw, firs movers hve o be exremely cuious. They hve o hink bou heir prners rusworhiness, which mkes honesy successful preference. In our model, firs movers receive perfec signl bou heir opponens ype, nd heir decision rule is simple: Only ener conrc if your opponen is rusworhy. Wih sochsic signl he rule would be very similr: Only ener if he signl is good enough. This illusres how our resuls would exend o he more generl cse of imperfec bu informive signls. Wih perfec signls, M ypes in he role of plyer 2 re never offered conrcs when p is low, while H ypes lwys ge conrcs. Wih imperfec signls, some M ypes would ge conrcs, while some H ypes would no (nmely, whenever he signl is wrong). If he signl is sufficienly informive, however, H ypes will ge more conrcs hn M ypes, which is required 19 To he bes of our knowledge, he firs uhors o highligh he possibiliy of such nonmonooniciies re Akerlof nd Dickens (1982). They sudy model wih cogniive dissonnce h my induce plyers o reevlue oucomes. 136

7 Americn Poliicl Science Review Vol. 95, No. 1 TABLE 3. Experimenl Sessions Session Mching Prob. 1 3 Prob. 4 9 Number of Subjecs Univ. 1 (RLLB) Rndom Low (.1) Low (.1) 20 B 2 (RMLB) Rndom Medium (.5) Low (.1) 28 B 3 (RHLB) Rndom High (.9) Low (.1) 28 B 4 (FMLB) Fixed Medium (.5) Low (.1) 16 B 5 (RLLH) Rndom Low (.1) Low (.1) 34 H 6 (RMLH) Rndom Medium (.5) Low (.1) 28 H for crowding in. Appendix A elbores on he cse of imperfec signls furher. Compring he wo lernive policies for replcing medium probbiliy regime ( more or less lw ), wo differences cn be observed. The firs is due o he dynmic nure of our nlysis. Wih more lw, more order is insnly chieved, since performnce nd enering becomes rionl for everyone. This is differen in he cse of less lw becuse fer he chnge of he regime he crowding process needs some ime. Though our experimenl resuls indice h djusmens cn be fs in smll groups, he behvior does no chnge insnly. This is n rgumen in fvor of he sndrd lw-nd-order pproch. Less lw, however, is less cosly. In our model, we disregrd ll fixed coss of legl conrc enforcemen nd vrible coss being funcion of p. Incresing p coss resources; decresing p sves resources. Here we do no wish o mke ny judgmen bou wh is he beer policy. Insed, we es our model s empiricl vlidiy in he lborory. EXPERIMENT Design In he experimenl design we ried o implemen our model s closely s possible. Subjecs plyed woperson conrc gme nd were rndomly mched. Six sessions wih ol of 154 subjecs were conduced, nd he gme ws repeed severl imes. To exmine crowding in of rus (more order wih less lw), we confroned subjecs in ll sessions wih low conrc enforcemen probbiliy during he ls rounds. In order o cree differen hisories, we vried he legl regime in he firs few rounds. If behvior is driven by incenives only, i should be independen of he hisory creed in erlier rounds nd should depend only on he curren legl regime. In conrs, if preferences dp o he legl regime, erlier hisory should ffec he likelihood of performnce in ler rounds. Experimenl subjecs were confroned wih idenicl pyoffs: 50 cens for ech plyer whenever he firs mover chose T (corresponds o choosing lernive A in he experimenl pyoff ble in Appendix C); $1.50 for ech plyer in cse of TP (corresponds o choosing lernive Y in he experimenl pyoff ble); $1.50 for he firs nd $1.20 for he second mover in cse of TPL (corresponds o he relizion of se in he experimenl pyoff ble); nd 20 cens for he firs nd $2.50 for he second mover in cse of TPL (corresponds o he relizion of se in he experimenl pyoff ble). The normlized pyoff vribles were.3, b 1, nd c.3. The probbiliies were.1,.5, nd Subjecs received pymen for ech round. Insrucions (see Appendix C) were neurlly frmed. Afer ech round, ggrege informion on oucomes ws provided, h is, firs nd second movers knew how mny conrcs were offered nd performed in he previous round. Providing informion on he disribuion of ypes only serves s conservive es of our model, becuse individuls ypes could no perfecly be deeced. The crowding model ssumes rndom mching, so we implemened srnger remen in five sessions nd used fixed-pir mching in one conrol session. Tble 3 presens n overview of ll sessions. The experimens were conduced he Universiy of Cliforni, Berkeley, nd Hrvrd Universiy (lbelled B nd H). Pricipion ws volunry, nd sudens were pid show-up fee of $5. The experimens ook pproximely 45 minues. Averge ernings were pproximely $15. Subjecs were idenified by code numbers only, nd nonymiy ws fully preserved. Afer signing consen form, pricipns were rndomly ssigned o he role of firs nd second mover; hey were given wrien insrucions, long wih n envelope conining code number shee nd nine decision shees, ll mrked wih he subjec s code number. Insrucions were repeed orlly, which llowed subjecs o sk quesions nd helped ensure h everyone undersood he decision sk. In ll bu session 4, hey were ruhfully ssured h hey would be rndomly mched wih differen person fer ech round. They were old h nine rounds would be plyed nd h hey would publicly be informed bou he ggrege oucome fer ech round. Individul resuls were prive informion. Subjecs could no nicipe he regime chnge before round 4, 21 bu when informed bou he new condiions, hey were lso old h hey would ply under he new regime for he remining six rounds. 20 Subjecs crried ou he chnce moves hemselves. Afer ech round rndomly chosen pricipn picked crd from pile of red nd blck crds. 21 The insrucions old hem neiher h he environmen would remin consn nor h i would chnge. 137

8 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding Mrch 2001 TABLE 4. D Round Session Behvior (RLLB) No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) (RMLB) No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) (RHLB) No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) (FMLB) No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) (RLLH) No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) (RMLH) No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) Noe: The ble summrizes behvior for ll sessions over ime. In RLLB, R snds for rndom mching, he firs L for low probbiliy in he firs few rounds, he second L for low probbiliy in he remining six rounds, nd B for Berkeley; nlogously, for he oher sessions. Resuls Our heory predics hisory-dependen behvior. The longer individuls re confroned wih low-p environmen, he more rusworhiness should be crowded in, nd he higher performnce res should be. High enforcemen probbiliies re expeced o be neurl wih respec o crowding, nd medium probbiliies should crowd ou rusworhiness. 22 Tble 4 presens he resuls for ll sessions in ll rounds. We briefly exmine session 4 wih fixed pirs, which is simple conrol session becuse he requiremens for crowding re no fulfilled. There is no rndom mching nd herefore no inercion on he group level. Insed, subjecs ply finiely repeed gme. Experimens on gmes wih cooperive gins (e.g., repeed public goods gmes or gif exchnge gmes) revel h cooperion res re ypiclly higher wih his kind of mching hn sndrd heory expecs. Furhermore, cooperion res seem o be relively sble over ime bu brek down owrd he end of he gme when he shdow of he fuure loses is power nd repuion no longer plys role. This srong drop in he ls rounds hs been clled n end gme effec (Selen nd Soecker 1983). 23 If he conrc gme is comprble o hese gmes, we should observe similr pern. Tble 4 confirms his expecion: We find h in he fixed-pirs session cooperion drops from 100% o 0% in he ls round. In conrs, our crowding heory predics incresing cooperion over ime nd rules ou n end-gme 22 These predicions cnno be viewed s deerminisic, since he lw of lrge numbers does no pply in he lborory (see lso Appendix B). 23 For ddiionl evidence, see Andreoni 1988 nd Croson 1996, who differenie beween cooperion bsed on repuion nd reciprociy. effec. I predics h rusworhy second movers perform becuse hey receive less uiliy from breching hn from performing, even hough breching leds o higher monery pyoff. Tble 5 shows ggrege d for rounds 4 o 9 in ll rndom-mching sessions. I suggess rend owrd more cooperion h does no brek down. On he conrry, he performnce re (he number of conrcs performed divided by he number of conrcs offered) reches is mximum in he ls round, which is in line wih he crowding predicion. We summrize by he following. RESULT 1. In he low probbiliy environmen wih rndom mching, performnce res increse over ime nd here is no end-gme effec. Our model ssumes h i is mos efficien if ll second movers perform. We expec high efficiency res insnly when enforcemen is srong, nd only slow increses in efficiency res over ime wih low enforcemen probbiliies. Figure 2 presens he efficiency res (he number of conrcs performed divided by he number of ll possible conrcs), for TABLE 5. Aggrege Rndom-Mching D for Rounds 4 o 9 Round Aggrege D No rus (T) Trus nd brech (T,P) Trus nd perf. (T,P) Performnce re Noe: Numbers in he firs hree rows re bsolue numbers; in he ls row hey re relive frequencies. 138

9 Americn Poliicl Science Review Vol. 95, No. 1 FIGURE 2. Efficiency Res over Time (Berkeley Only) he sessions wih rndom mching. In he shor run, high enforcemen probbiliies led o he mos efficien oucomes. In he medium erm, when he crowding dynmics sr o become relevn, he low-p environmen is mos efficien. The longer subjecs were confroned wih low-p environmen, he less pplicble were he differenil effecs of heir respecive crowding hisories. RESULT 2. In he shor run, efficiency res re highes when enforcemen is srong; in he medium erm, hey re highes in he low-probbiliy environmen; in he long run, he differenil effecs of enforcemen nd crowding end o vnish. In order o nlyze he d more horoughly, we nex esimed binry choice models for firs movers propensiy o ener nd second movers propensiy o perform, nd we conrolled for he relevnce of crowding compred o economic incenives nd for fixed effecs of he universiy group. In order o mesure crowding, le j nd le 1ifp is smll in group j in round ; 0ifp is high in group j in round ; nd 1ifp is medium in group j in round ; 1 CROWD j h j. h 1 The vrible j indices wheher our heory predics crowding in ( 1), crowding ou ( 1), or no crowding (0), nd he vrible CROWD j summrizes he crowding hisory of group j up o round. If he heory is relevn, we would expec CROWD j o help explin he propensiy of second movers o perform. 24 In ddiion o CROWD, we include number of vribles s covries. PERFORM j 1 is he performnce re in group j in round 1, mesured s he number of conrcs performed divided by he number of conrcs offered. ENTER j 1 is he re of enering in group j in round 1, mesured s he number of conrcs enered divided by he number of firs movers in group j. INCENT j is dummy vrible indicing wheher he firs mover hs n incenive o ener he conrc if only monery pyoffs ply role, h is, INCENT j 1ifp is medium or high, 0 oherwise. INCPERF j is dummy vrible indicing wheher he second mover hs n incenive o perform he conrc if only monery pyoffs ply role, h is, INCPERF j 1ifp is high, 0 oherwise. UNIV j is dummy vrible indicing he universiy group o which j belongs; UNIV j 1 for universiy H nd 0 for universiy B. 24 I cn be rgued h his definiion is somewh rbirry, nd we gree. By no mens do we clim h CROWD cpures he rue sory, nd cerinly we do no clim h crowding is liner. Probbly i is no. We hink, however, h his Byesin pproch. In he bsence of ny specificion h is priori more rionl hn noher, he bove definiion is he mos simple nd cn be jusified by king expeced vlues over eqully probble lernives. Furhermore, if we find significn effec of CROWD in is curren form, ny opiml definiion would increse is significnce. 139

10 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding Mrch 2001 TABLE 6. Propensiy o Ener (Firs Movers) nd o Perform (Second Movers) Conrc (Logisic Regression) Wihou Subjec Dummies Wih Subjec Dummies Firs Movers Coef. S.E. p R Coef. S.E. p R CROWD j PERFORM j ENTER j INCENT j INCPERF j UNIV j Consn Second Movers CROWD j PERFORM j ENTER j INCENT j INCPERF j UNIV j Consn Noe: N 552 for firs movers, N 312 for second movers. R is he pril conribuion mesuring he relive impornce of ech vrible. Furhermore, we lso rn (logisic) regressions including subjec dummies S ji. 25 The esimed model wihou subjec dummies is q rji ln 0 CROWD 1 q j rji 1 PERFORM j 1 2 ENTER j 1 3 INCENT j 4 INCPERF j 5 UNIV j ε ji, wih q rji indicing eiher firs mover i s propensiy o ener or second mover i s o perform. Tble 6 presens he resuls for firs movers nd second movers. All sessions wih rndom mching re included. We find h firs movers behvior is minly driven by he economic incenives hey fce nd by he performnce re of he ls round. In he esimion wihou subjec dummies we lso find significn effec of he universiy dummy: On verge, H sudens ener less ofen hn B sudens. Since his dummy loses is significnce when subjec dummies re inroduced, we re confiden h he difference beween H nd B is no due o some differences in he experimenl procedures (of which we were unwre). Rher, he difference is on he individul level. In he cse of second movers, we find h H sudens re more rusworhy hn B sudens. Agin, his effec disppers when we conrol for differences beween individuls. In he esimion wihou subjec dummies, hree ddiionl vribles help explin second movers 25 We use nesed effec coding (see Königsein 1998) becuse he subjec dummies re nesed in he universiy dummy. decisions: economic incenives (less breching if brech is deerred), ls round s performnce re (such h here is some ineri), nd crowding hisory (he longer subjecs inerc in low-p environmen, he more likely hey re o be rusworhy). Only he ls vrible remins significn when we include subjec dummies. We summrize s follows. RESULT 3. Firs movers propensiy o ener conrc (i.e., o selec lernive B in he experimenl pyoff ble) minly depends on heir monery incenives nd on second movers previous performnce re. Second movers propensiy o perform minly depends on heir crowding hisory. The second pr of resul 3 is he key finding of his sudy becuse i confirms he quliive predicions of he crowding heory. I is resul on he ggrege level, however, so i seems worhwhile o invesige wheher he heory lso predics individul behvior. The min predicion of our model on he individul level is h, in he low-p environmen, subjecs who brech once re much more likely o swich o hones behvior hn re hones subjecs o swich o breching. To nlyze his hypohesis we simply coun how mny second movers swich from breching o performing once p is low. We lso coun how mny second movers swich in unprediced direcions nd how mny never swich once p is low. Tble 7 presens he resuls. The picure is cler. In he low-enforcemen regime 53.6% of ll subjecs chnged heir behvior, nd 89.2% of hese swiched in he prediced direcion. In oher words, 33 second movers breched in he erly phses of he experimen nd hen performed ler, even hough money-mximizing sregy fvored he 140

11 Americn Poliicl Science Review Vol. 95, No. 1 TABLE 7. Individul Behvior in he Low- Probbiliy Environmen Session Brech3 Perform Unprediced Swiches Behvior Fixed N 1 (RLLB) (RMLB) (RHLB) (RLLH) (RMLH) Tol old behvior. None of hese 33 subjecs swiched bck o breching. They becme rusworhy, even hough hey sred by breching. There were very few unprediced swiches. 26 The null hypohesis h behvior swiching is rndom cn be rejeced significnce level of.01%. Thus, he crowding heory s predicions re confirmed by individul d. CONCLUSION In our model he (legl) rules of gme hve no only shor-run bu lso long-run effecs on behvior becuse hey ffec preferences. In conrcul relionship, economic incenives hve nonmonoonic influence on conrc performnce. Our model complemens recen work on he inercion of rules nd preferences (e.g., Fehr nd Schmid 1999), which only llows for differences in preferences, wheres our model permis preferences o chnge. I suggess h he rules of he gme deermine which preferences domine. More specificlly, i predics h low levels of legl conrc enforcemen increse rusworhiness. Becuse firs movers cnno rus he legl sysem, hey ener conrc only if hey cn rus he second mover. They re creful bou he decision, which mkes rusworhiness successful ri. Arguing from differen perspecive, ohers come o very similr conclusions. Mnsbridge (1999, 305), who discusses vrious wys of encourging rusworhiness nd rus, concludes: When he rusworhiness of populion is oo low o susin generl snce of iniil rus, nd when geogrphic nd socil mobiliy mke repuionl, kin nd locl sncions less vible, he rusworhy members of given populion will benefi from finding wys of disinguishing hemselves nd oher rusworhy individuls from he unrusworhy...herusworhy would find i useful o rin hemselves o recognize suble signs of rusworhiness in ohers nd lso o develop in hemselves signs h could no esily be mimicked. Differenil incenives o lern bou ohers disposiions my ccoun for some of he cross-culurl vriion in behvior found in lborory experimens. For exmple, Ymgishi, Cook, nd Wnbe (1998) rgue h Jpnese subjecs re less rusing nd rusworhy hn Americn subjecs becuse conrc enforcemen mechnisms nd ssurnce srucures re 26 Noice h, s he heory is sochsic, hese insnces re no enirely unprediced. more prevlen in Jpn hn in he Unied Ses. This corresponds o our high-p seing nd our finding h when conrcs re compleely specified, inerpersonl rus is replced by insiuionl rus in he legl sysem. Firs movers ener conrc becuse second movers re deerred from breching. Previous work on crowding focuses on he relevnce of preferences when conrcs re complee. 27 We show h rusworhiness is crowded ou no by complee conrcs bu by semispecified conrcs. A inermedie levels of enforcemen, second movers re no ye deerred from breching, nd firs movers find enering conrc finncilly more rcive hn remining ouside. Inerpersonl rus is replced by insiuionl rus in he legl sysem, nd genuine rusworhiness is crowded ou. Semispecified conrcs cuse nonmonoonic behvior: More order cn resul from less lw, which yields moivion-compible environmen (Bohne nd Frey 1997), nd from more lw, which yields n incenive-compible environmen. Closely reled o his finding re resuls by Hung nd Wu (1994) nd Huck (1998). Using psychologicl gme heory, 28 Hung nd Wu (1994) model gmes very similr o ours nd show h if pyoffs lso depend on beliefs, hen differen levels of order my resul from he sme level of lw; h is, here is mulipliciy of equilibri. Simply speking, here is one equilibrium in which everyone believes sociey is funcioning well nd rus is rewrded, nd his becomes self-fulfilling. If everyone believes he opposie, h becomes self-fulfilling. A crucil difference beween he Hung nd Wu pproch nd ours is h preferences (regrding pyoffs nd beliefs) re fixed in heir model. Thus, no obvious dynmics led from one se o noher, nd here is no srighforwrd link beween insiuionl design nd behvior. In conrs, Huck (1998) shows in he conex of criminl lw h if preferences re llowed o chnge, socilly desirble behvior cn be induced wih lower levels of (monery) punishmens hn one would conclude ssuming fixed preferences. In our experimen we ried o mp he heoreicl ssumpions ino lborory environmen s precisely s possible, nd he resuls suppor our quliive predicions. Similr o Huck, we find h if here is enough ime for he crowding dynmics o unfold, environmens wih low conrc enforcemen cn produce oucomes s efficien s high levels of enforcemen. To he bes of our knowledge, we provide he firs empiricl evidence of long-run effecs of legl rules on behvior. Alhough experimens simplify reliy, our conrc gme is informed by rel-life insiuions; i represens siuion in which legl enforcemen leds 27 See Timuss 1970 for policy exmples; Frey 1997 for he crowding ou of x morle; Frey nd Oberholzer-Gee 1997 for he crowding ou of civic duy in siing conex; nd Gneezy nd Rusichini 1999 for he crowding ou of prenl discipline in dycre cener. For experimenl evidence, see he exensive survey of psychology sudies by Deci, Koesner, nd Ryn 1999 s well s Flk, Gächer, nd Kovcs For he disrupion of implici greemens in he orgnizionl conex, see Arrow See Genekoplos, Perce, nd Scchei

12 More Order wih Less Lw: On Conrc Enforcemen, Trus, nd Crowding Mrch 2001 o perfec expecion dmges, nd rnscion coss re lloced ccording o he English legl cos llocion rule, where he loser pys ll legl coss. The long run in our experimen is nine rounds (or 45 minues), which we inerpre s conservive es of crowding. In fc, we were surprised h he dynmics unfolded so quickly nd h subjecs inclinion o rus nd o be rusworhy chnged in such shor ime. The resuls suppor he view h insiuionl chnges ffec behvior, bu hey lso revel h, by ffecing behvior, insiuions ffec preferences. APPENDIX A. A SIMPLE CASE WITH IMPERFECT SIGNALS Suppose firs movers receive, before mking heir decision o ener conrc, signl s R. The signl echnology is he following. If plyer 2 s rue ype is H, hen he signl is 1 ε; ε is normlly disribued, wih men zero nd vrince 2.If plyer 2 s rue ype is M, he signl is 0 ε, nd ε comes from he sme norml disribuion. How will plyer 1 decide wheher o ener he conrc? Nohing chnges in he cse of 1 : She will lwys ener. (This follows from he fc h she eners even when she knows for sure h plyer 2 is of ype M.) In cse of 1, plyer 1 hs o upde her beliefs bou he ype of plyer 2 by using he Byes rule. She will ener if nd only if he probbiliy for plyer 2 being of ype H is lrge enough. Hence, here will be criicl vlue s, such h plyer 1 eners if s s nd sys ou oherwise. Given s nd he signl echnology, we cn now compue he probbiliies wih which he wo differen ypes re offered conrcs. Using hese probbiliies we cn clcule he expeced pyoffs for boh ypes or, in populion model, he verge pyoff for boh ypes. Obviously, H ypes will lwys ge more conrcs hn M ypes. (I is more likely h signl s exceeds s for H ypes.) Ye, M ypes benefi from profible brech. The dominnce of one of hese effecs depends criiclly on how noisy he signl is, h is, on vrince 2. There re wo boundry cses. (i) 3 0 is he cse of perfec signl, nd he firs effec is sronger hn he second (rusworhiness is crowded in). (ii) 3 is he cse wihou signl, nd he second effec is sronger (rusworhiness is crowded ou). Obviously, we cn now find criicl sndrd deviion,, h induces idenicl expeced monery pyoffs for boh ypes. If he sndrd deviion is bove his level, M ypes will ern more hn H ypes, nd he hird resul of proposiion 2 will be reversed. If he sndrd deviion is below his level, he originl resul is resurreced. APPENDIX B. A STOCHASTIC MODEL OF INDIVIDUAL PREFERENCE ADAPTATION Consider lrge populion of individuls who my be heerogeneous wih respec o heir preferences. Le be he finie se of possible preferences, nd le be ypicl elemen of his se. When individuls inerc, heir behvior nd ernings depend on he exc siuion hey fce nd on heir ype. For given siuion (e.g., gme h specifies only monery pyoffs) we cn denoe he monery pyoff of individul i s i ( i, i ), where i denoes he ypes of ll individuls wih whom i is inercing. (In siuions wih muliple equilibri, his implies h redy selecion crierion is hnd.) Individuls re mched by mching scheme S, h is, S mps he se of individuls iself. The verge pyoff erned by individuls of cerin ype, depends on, S, nd he curren profile of ypes, denoed by he cumulive disribuion funcion F( ), which cn be wrien s (,S,F( )) or s ( ). For convenience, we resric he model o discree ime, being he ime index. Accordingly, le f ( ) denoe he shre of individuls of ype ime. The expression f 1 f g f reflecs he growh re of ype. We ssume h preference chnges occur sochsiclly nd wihin individuls. Le q(, ) be he probbiliy h n individul s preference chnges o. Obviously, q, 1. Furhermore, we ssume h hese probbiliies depend on wo fcors, economic success nd conformiy. 29 To cpure he role of conformiy we ssume he following. ASSUMPTION 1 (conformiy). Ceeris pribus, q(, ) is proporionl o f( ). Assumpion 1 implies h q(, ) cn be wrien s f( ) imes some oher funcion Q(, ). In order o embed he role of economic success, we ssume he following. ASSUMPTION 2 (economic success). Q(, ) only depends on ( ) nd is sricly incresing in i. This gives rise o sochsic process in which F( ) develops over ime. Below we show h, under cerin ddiionl (regulriy) ssumpions, such process behves like growh-monoonic evoluionry process, h is, like process ssumed in our ex: Shres of ypes grow ccording o heir relive economic success. ASSUMPTION 3 (regulriy). () The mching scheme S specifies rndom mching. (b) The populion is lrge enough for he lw of lrge numbers o pply. THEOREM 1. Under ssumpions 1 o 3 he dynmic process of individul preference dpion behves like growhmonoonic evoluionry process, h is, g( ) g( ) N ( ) ( ). Proof. Wih ssumpions 1 nd 3 we cn wrie: Therefore, f 1 f Q, f. g f g N Q, f Q,. Due o ssumpion 2 Q(, ) Q(, ) N ( ) ( ). Hence, he clim follows. Q.E.D. The widely used replicor dynmics belong o he clss of growh-monoonic evoluionry processes, nd i is esy o see when process of individul preference dpion behves like he replicor dynmics. 29 For heories of conformiy, see Akerlof 1997; Bernheim 1994; Bowles 1999; Boyd nd Richerson

13 Americn Poliicl Science Review Vol. 95, No. 1 COROLLARY 1. If q, f f, hen he process of individul preference dpion behves like he replicor dynmics. Proof. The proof is srighforwrd. APPENDIX C. SAMPLE INSTRUCTIONS Q.E.D. For he condiion of rndom mching of subjecs, medium probbiliy, plyer 1, nd he firs phse of he experimen, insrucions were s follows. Welcome o his reserch projec! You re priciping in sudy in which you hve he opporuniy o ern csh. The cul moun of csh you will ern depends on your choices nd he choices of oher persons. A he end of he sudy, he moun of csh erned will be dded o your show-up fee nd pid o you in csh. Wh he sudy is bou: The sudy is on how people decide. You re rndomly mched wih noher person presen in his room. You nd he oher person hve o choose beween wo lernives. The pyoff ble ells you how much money you ern depending on wh you choose nd wh he oher person chooses. How he sudy is conduced: The sudy is conduced nonymously, wihou communicion beween he pricipns, nd repeed 9 rounds. Pricipns re only idenified by leer or number clled code number. Neiher he oher pricipns nor he resercher will ever know how you decide. You re rndomly mched wih noher person fer ech round. You will never inerc wih he sme person gin. You re person 1. Sr of he sudy. Round 1: The pyoff ble reds s follows. Firs you hve o choose beween A nd B. If you choose A, you nd he oher person receive 50 cens ech. If you choose B, person 2 ges o choose beween Y nd Z. If person 2 chooses Y, you nd person 2 receive 150 cens ech. If person 2 chooses Z, chnce decides bou your ernings. You ern 150 cens wih probbiliy 0.5 ( ) nd 20 cens wih probbiliy 0.5 ( ), h is, your expeced ernings fer chnce move re 85 cens. The oher person erns 120 cens wih probbiliy 0.5 ( ) nd 250 cens wih probbiliy 0.5 ( ), h is, his or her expeced ernings fer chnce move re 185 cens. Pyoff Tble Who Decides Alernives Ernings for 1 Ernings for 2 Person 1 Person 2 Chnce A B 3 3 Y Z 3 3 (prob.5) (prob.5) Now, plese open your envelope. I conins 9 decision shees nd code number shee. Plese ke everyhing ou of he envelope. Keep he code number shee. Then choose beween A nd B. Indice your choice on he decision shee mrked Round 1, pu his decision shee bck ino he envelope, nd pu i ino he box which we will pss round. Keep ll oher decision shees. Persons 2 re rndomly lloced n envelope nd sked o look your decision nd if hey ge o mke choice indice heir choice of eiher Y or Z on he decision shee. Decision shees will be pu bck ino he envelope nd ino he box. We collec ll decision shees nd coun how mny people in his room chose A, B, Y, nd Z, respecively, nd inform ll of you of he ggrege oucome of he firs round. We hen give you he envelope bck. Plese ke he decision shee ou. The informion on he decision shee is prive. Plese do no shre i wih nyone else. Chnce now decides wheher or will be relized in his round. For his purpose we drw crd from pile wih five red nd five blck crds. Red implies, blck implies. We deermine your ernings ccording o your choice nd he choice of he oher person fer he sudy is over. Your ernings will be pid o you in csh. End of round 1. REFERENCES Akerlof, George A Socil Disnce nd Socil Decisions. Economeric 65 (Sepember): Akerlof, George A., nd Willim T. Dickens The Economic Consequences of Cogniive Dissonnce. Americn Economic Review 72 (3): Andreoni, Jmes Why Free Ride? Sregies nd Lerning in Public Goods Experimens. Journl of Public Economics 37 (Februry): Arrow, Kenneh The Limis of Orgnizion. New York: Noron. Axelrod, Rober The Evoluion of Cooperion. New York: Bsic Books. Bron, Jmes N., nd Dvid Kreps Sregic Humn Resources. New York: Wiley. Becker, Gry S Alruism, Egoism, nd Geneic Finess: Economics nd Sociobiology. 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