Effects of Financial Incentives on the Breakdown of Mutual Trust

7 Pages Posted: 15 Oct 2004 Last revised: 24 Feb 2008

See all articles by James E. Parco

James E. Parco

Colorado College

Amnon Rapoport

University of Arizona - Eller College of Management

William E. Stein

Texas A&M University - Mays Business School

Abstract

Disagreements between psychologists and economists about the need for and size of financial incentives continue to be hotly discussed. We examine the effects of financial incentives in a class of interactive decision making situations, called centipede games, in which mutual trust is essential for cooperation. Invoking backward induction, the Nash equilibrium solution for these games is counterintuitive. Our previous research showed that when the number of players in the centipede game is increased from two to three, the game is iterated in time, the players are re-matched, and the stakes are unusually high, behavior approaches equilibrium play. Results from the present study show that reducing the size of the stakes elicits dramatically different patterns of behavior. We argue that when mutual trust is involved the magnitude of financial incentives can induce a considerable difference.

Keywords: Centipede game, backward induction, experimental study, high vs. low stakes

JEL Classification: C92, D81

Suggested Citation

Parco, Jim and Rapoport, Amnon and Stein, William E., Effects of Financial Incentives on the Breakdown of Mutual Trust. Psychological Science, Vol. 13, pp. 292-297, 2002. Available at SSRN: https://ssrn.com/abstract=605204

Jim Parco (Contact Author)

Colorado College ( email )

Department of Economics and Business
14 E. Cache la Poudre St.
Colorado Springs, CO 80903
United States
719-389-6416 (Phone)
719-389-6927 (Fax)

HOME PAGE: http://www.coloradocollege.edu/dept/EC/parco.asp

Amnon Rapoport

University of Arizona - Eller College of Management ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States
520-621-9325 (Phone)
520-621-4171 (Fax)

William E. Stein

Texas A&M University - Mays Business School ( email )

INFO Dept.
MS4217
College Station, TX 77843-4217
United States
979-845-4339 (Phone)

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