Does prestige / social pressurechange managers‘ risk appetite?

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Does prestige / social pressure change managers‘ risk appetite?

Golo Feige, Michael May, Michael Specht Department of Economics - LMU Munich Chair for Behavioural Economics and Experimental Economics

Experimental Economics

Prof. Martin Kocher, Summer Term 2009

               •                

Munich, June 18

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Agenda

Idea…

1. Motivation 2. Risk

3. Status

4. Risk-taking and status combined

Experiment…

Hypothesis...

Statistics…

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Munich, June 18. Golo Feige, Michael May, Michael Specht 3

Idea – 1. Motivation

Motivation

Financial crises…

• Bank managers are to blame for the current financial crises?

• Managers take excessive risks to maximize their personal income?

> Focus: Risk taking of managers

• Managers are very sensitive for status symbols and “non-monetary- incentives”?

> Focus: Status seeking of managers

• Change subjects their risk taking behaviour due to social pressure?

Our Question…

Status seeking

Risk taking

Social pressure ?

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Idea – 2. About risk-seeking

Definition of risk

Forward looking managerial decisions are often contingent. Risk is the uncertainty managers have to face making decisions

(Burger and Buchhart 2001).

Basis of theoretical measure of risk is frequently Bernoulli‘s principle (µ-σ-principle).

Role of risk in financial institutions

„It seems appropriate to use the old cliché, ‘banks die of a heart

attack in the treasury or a cancer in the loan book’. As the funding markets loosen, we believe that credit quality will likely be the

differentiating factor of relative performance.“

Goldman Sachs, 30 October 2008

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Idea – 3. About status-seeking

Status

Status in our terms is a non-monetary social incentive for human beings.

Role of status in financial institutions

• Status is often seen as the most important incentive for managers

except of monetary incentives like bonuses and perks. This is the case especially in financial institutions because success is very easy to

measure there.

• “Be the best” piles the managers under immense social pressure in their peer group.

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Idea – 4. Risk-taking and status combined

Theory

Standard microeconomic theory doesn’t provide a normative theory of social pressure. Why? Because social pressure is mostly irrational.

But: Clemens (2006) shows positive tradeoff between status and attitude towards risk.

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Experiment (1/3)

Fix after 10 rounds Upside per round Downside per round

20 0.5 -0.5

20 1 -1

20 2 -2

Project A Project B Project C

Payments are added/deducted from the current-balance after each round

Projects and Payments

P_Win= P_Lose = 0.5. Explained to Subjects as “Flip-a-coin”

Our Experiment

• Subjects have to perform a very simple asset choice.

• The assets are different in risk so we can measure the risk-taking of the subjects.

• Some are shown their relative performance to the group, some are not.

(Treatment 1 vs. 2)

• Differences in these two treatments should explain the importance of social pressure on risk taking.

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Experiment (2/3)

Treatment I: No ranking displayed Treatment II: Ranking displayed

• In the first session, one group gets treatment I and the other one treatment II

• In the next session, group treatments are reversed (Identification of learning / order effects)

Ranking

• Visible to subjects all the time

• Based on the current-balance of each subject

• Simple table showing the subject’s position and the position of the other group-members

Treatments

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Experiment (3/3)

Experiment

 Lab/ Computerized

 two Sessions

Treatments

 2

 Within subject

Subjects

 6 students

Rounds

 10 per session

Information

 3 projects, 6 players, 10 rounds, win- loose message after each round, payments , plus current-balance (ranking) in treatment II

Matching

 Identification possible through the ranking with identification number

 Identification number does not reveal identity

Observations

 For each subject and each round:

project choice, ranking-Position, current balance (panel-like data)

 After last round: questionnaire with demographics

Framework

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Hypothesis

Prediction – Standard microeconomics

If two prospects have the same expected value, individuals prefer that one with the smaller variance. Social pressure does not play a role in decision making.

Prediction – Prospect Theory

Our Hypothesis

Social comparison makes “irrational gambling” more likely at both ends.

We expect more risk taking by the “maybe loosers” and “maybe winners”.

People are risk seeking for losses and risk averse for gains.

This also applies to status concerns, see Harbaugh and Korinienko (2001)

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Statistics

Applicable Methods

• Distributional tests (Chi²-Test, Kolmogorov-Smirnov) comparing the two treatments

• Otherwise (better): Panel-Logit, Ordered-Logit

• Dependent Variable: Risk Behaviour (Categories)‏

• Main explanatory Variables: Treatment-Dummy, Ranking-position (i.e.

balance)

• Controls: (Demographics, maybe ask for emotions/feelings?)‏

• Sessional Comparisons: Identifying learning Effects

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Extensions

Uncertainty of run-time

Subjects know that experiment may only last 5 rounds instate of 10 rounds (additional treatment).

Do this uncertainty of run-time affect the subjects‘ risk appetite?

Ranking Bonus

Subjects with prime ranking position receive an additional bonus (monetary).

Do subjects seek even more risk?

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Thank you for your kind attention Thank You for Your kind attention

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• Burger, Anton and Buchhart, Anton: Risiko-Controlling, 2001, pp. 7-13

• Clemens, Christiane: “Status Concerns and Occupational Choice under Uncertainty” Advances in Theoretical Economics 2006 6:1, article 4

• Harabaugh, Rick and Korinienko, Tatiana: “Local status and Prospect Theory” Claremont Colleges Working paper, January 2001

• Kahneman, Daniel and Tversky, Amos: „Prospect Theory: An Analysis of Decisions under Risk“ Econometrica 1979, 47:2, pp. 263-291

• Stoner, J.A.F.: „A comparison of individual and group decisions involing risk“ Unpublished M.A. thesis. School of Industrial Management, M.I.T.

1961

• Wallach, M.A., Kogan, N. and Bem, D.J.: Group influence on individual risk taking. J. Abnorm. Soc. Psychol. 1962, 65, pp 75-86

References

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Backup

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Reference point

chances

konkav

„risk avers“ for gains

konvex (steeper)‏

„risk seeking“ for losses

Value Function

Prospect Theory

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Fees

• approximately 20 € per subject per session

• 20 fix + 0 variable (up- and downside probability equal)

Sum of Fees: 20(euro)*2(sessions)*6(subjects) = 240 EURO

Equipment

Laboratory,...

Computer,...

Staff,...

Preparation,...