Are We Strategically Naïve or Guided by Trust and Trustworthiness in Cheap-Talk Communication?

Abstract

Cheap-talk communication between parties with conflicting interests is common in many business and economic settings. Two distinct behavioral economics theories, the trust-embedded model and the level-k model, have emerged to explain how cheap talk works between human decision makers. The trust-embedded model considers that decision makers are motivated by non-pecuniary motives to be trusting and trustworthy. In contrast, the level-k model considers that decision makers are purely self-interested, but limited in their ability to think strategically. While both theories have been successful in explaining cheap-talk behaviors in separate contexts, they point to contrasting drivers for human behaviors. In this paper, we provide the first direct comparison of both theories within the same context. We show that, in a cheap-talk setting that well represents many practical situations, the two models make characteristically distinct and empirically distinguishable predictions. We leverage past experiment data from this setting to determine what aspects of cheap-talk behavior each model captures well, and which model (or combination of models) has better explanatory power and predictive performance. We find that the trust-embedded model emerges as the dominant explanation. Our results thus highlight the importance of investing in systems and processes to foster trusting and trustworthy relationships in order to facilitate more effective cheap-talk interactions.

Keywords: Behavioral Economics, Bounded Rationality, Cheap Talk, Level-k Thinking, Trust, Trustworthiness