Discussion Paper No. 2010‐21
Daniele Nosenzo, Theo Offerman, Martin Sefton and Ailko van der Veen December 2010
Inducing Good Behavior: Bonuses versus Fines in Inspection Games
CeDEx Discussion Paper Series
ISSN 1749 ‐ 3293
The Centre for Decision Research and Experimental Economics was founded in 2000, and is based in the School of Economics at the University of Nottingham. The focus for the Centre is research into individual and strategic decision‐making using a combination of theoretical and experimental methods. On the theory side, members of the Centre investigate individual choice under uncertainty, cooperative and non‐cooperative game theory, as well as theories of psychology, bounded rationality and evolutionary game theory. Members of the Centre have applied experimental methods in the fields of public economics, individual choice under risk and uncertainty, strategic interaction, and the performance of auctions, markets and other economic institutions. Much of the Centre's research involves collaborative projects with researchers from other departments in the UK and overseas. Please visit http://www.nottingham.ac.uk/economics/cedex/ for more information about the Centre or contact Sue Berry Centre for Decision Research and Experimental Economics School of Economics University of Nottingham University Park Nottingham NG7 2RD Tel: +44 (0)115 95 15469 Fax: +44 (0) 115 95 14159 firstname.lastname@example.org The full list of CeDEx Discussion Papers is available at http://www.nottingham.ac.uk/economics/cedex/papers/index.html
Inducing Good Behavior: Bonuses versus Fines in Inspection Games by Daniele Nosenzo * , Theo Offerman ** , Martin Sefton* and Ailko van der Veen** 10 December 2010
Abstract We examine the effectiveness of bonuses and fines in an ‘inspection game’ where an employer can learn the effort of a worker through costly inspection. Standard game theoretic analysis predicts that fines discourage shirking, whereas bonuses encourage shirking. In contrast, ownpayoff effects suggest that both fines and bonuses discourage shirking. In an experiment we find that fines are more effective than bonuses in reducing shirking. However, we do not find that bonuses encourage shirking. Behavioral theories based on Impulse Balance Equilibrium or Quantal Response Equilibrium provide a good account of deviations from Nash equilibrium predictions. Keywords: Inspection Games; Costly Monitoring; Rewards and Punishments; Bonuses and Fines; Quantal Response Equilibrium; Impulse Balance Equilibrium; Experiment. JEL Classification Numbers: C70, C72, C92 Acknowledgement: We thank Daniel Seidmann, participants at the 2010 ESA Conference in Copenhagen, the 2010 CREED-CeDEx-CBESS Meeting in Amsterdam, and seminar audiences in Amsterdam for useful comments. Daniele Nosenzo acknowledges support from the Leverhulme Foundation (ECF/2010/0636).
School of Economics, University of Nottingham, Nottingham, NG7 2RD, United Kingdom CREED, Department of Economics, University of Amsterdam, 1018 WB, Netherlands 1
1. INTRODUCTION There are many situations where authorities have preferences over individuals’ choices. A tax authority wants taxpayers to truthfully report income, an employer wants an employee to work hard, a regulator wants a factory to comply with pollution regulations, police want motorists to observe speed limits, etc. A fundamental problem for authorities is how to induce compliance with desired behavior when individuals have incentives to deviate from such behavior. A standard approach is to monitor a proportion of individuals and penalize those caught misbehaving. To further encourage compliance, the authority may consider rewarding an individual who was inspected and found complying. For example, in 2003 the National Tax Service (NTS) of Korea...