Tag Archives: incentives

Directing help-seekers to resources is playing hot potato

In several mental health first aid guidelines, one of the steps is to direct the help-seeker to resources (suggest asking friends, family, professionals for help, reading materials on how to cope with the mental condition). This can provide an excuse to play hot potato: send the help-seeker to someone else instead of providing help. For example, the therapist or counsellor suggests seeing a doctor and obtaining a prescription, and the doctor recommends meeting a therapist instead.

The hot potato game is neither limited to sufferers of mental health issues, nor to doctors and counsellors. It is very common in universities: many people „raise awareness”, „coordinate” the work of others or „mentor” them, „manage change”, „are on the team or committee”, „create an action plan” (or strategy, policy or procedure), „start a conversation” about an issue or „call attention” to it, instead of actually doing useful work. One example is extolling the virtues of recycling, as opposed to physically moving recyclable items from the garbage bin to the recycling bin, and non-recyclable waste in the other direction. Another example is calling attention to mental health, instead of volunteering to visit the mentally ill at home and help them with tasks. Talking about supporting and mentoring early career academics, as opposed to donating part of one’s salary to create a new postdoc position, thereby putting one’s money where one’s mouth is.

All the seeming-work activities mentioned above allow avoiding actual work and padding one’s CV. Claiming to manage and coordinate other people additionally helps with empire-building – hiring more subordinates to whom one’s own work can be outsourced.

To motivate people to do useful work, as opposed to coordinating or managing, the desirable outcomes of the work should be clearly defined, measured, and incentivised. Mere discussions, committee meetings and action plans should attract no rewards, rather the reverse, because these waste other people’s time. More generally, using more inputs for the same output should be penalised, for example for academics, receiving more grant money should count negatively for promotions, given the same patent and publication output.

One way to measure the usefulness of someone’s activity is to use the revealed preference of colleagues (https://sanderheinsalu.com/ajaveeb/?p=1093). Some management and coordination is beneficial, but universities tend to overdo it, so it has negative value added.

Gambling deterrence mechanism

Compulsive gambling is driven by the hope of winning a large amount, so one way to deter gambling addiction is to forbid paying out winnings to people registered as having this problem. In a one-shot interaction, casinos and lottery organisers clearly have an incentive to keep both the stakes and the winnings, but problem gambling is repeated. Sufficiently patient casinos are motivated to establish a reputation for paying out winnings, if the punishment is small or unlikely enough, because such reputation attracts other gamblers, which increases the long-run expected profit of the casino. The gamblers are not interested in reporting the casino for illegally paying out, because they benefit from the payout, and the closure of the establishment would prevent them from satisfying their craving.

However, the gamblers’ desire for big winnings, even with very low probability, can be used to motivate them to report – the law can offer a large sum to anyone who proves that a casino made an illegal payout. The reward can be financed from an even larger fine levied on the law-breaking casino. The reward should of course be in addition to any winnings of the whistleblower if the latter is a patron of the casino, because a gambler should not lose money by reporting. Gamblers are impatient, unlike casinos, so the repeated interaction with an establishment does not outweigh an immediate payout, even if collecting the payout leads to less opportunity to gamble in the future.

Overbidding incentives in crowdfunding

Crowdfunding campaigns on Funderbeam and other platforms fix a price for the shares or loan notes and invite investors to submit the quantity they want to buy. If demand exceeds supply, then the financial instruments are rationed pro rata, or investors requesting quantities below a threshold get what they asked and others receive the threshold amount plus a pro rata share in the remaining quantity after the threshold amounts are allocated. Rationing creates the incentive to oversubscribe: an investor who wants n shares and expects being rationed to fraction x of her demanded quantity will rationally put in the order for n/x>n shares to counteract the rationing. For a mechanism not to invite such manipulation, the amount allocated to a given bidder in the event of oversubscription should not depend on that bidder’s bid quantity. For example, everyone gets the minimum of their demanded amount and a threshold quantity, where the threshold is determined so as to equate demand and supply. If there are s shares and all m investors demand more than s/m, then each gets s/m.

If some investors demand less than s/m, then the allocation process is recursive as follows. The i1 investors who asked for less than s/m each get what they requested. Their total t1 is subtracted from s to get s1 and the number of remaining investors reduced to m1=m-i1. Then the i2 investors asking for less than s1/m1 get what they demanded (t2 in total), and the new remaining amount s2=s1-t2 and number of investors m2=m1-i2 determined. Repeat until the number of investors asking for less than sj/mj is zero. Divide the remaining amount equally between the remaining investors.

An alternative is to let the market work by allowing the price to adjust, instead of fixing it in advance. Everyone should then submit demand curves: for each price, how many shares are they willing to buy. This may be too complicated for the unsophisticated crowdfunding investors.

However, complexity is probably not the main reason for the inefficient allocation mechanism that invites overbidding. The crowdfunding platform wants to appear popular among investors to attract companies to raise funds on it, so wants to increase the number of oversubscribed campaigns. Rationing is a way to achieve such manipulation if the fundraisers ignore the investors’ incentives to overbid and do not compare the platform to competing ones with similar allocation mechanisms. If fundraisers are irrational in this way, then they do not choose competing platforms without overbidding incentives, because funding campaigns there seem to attract less investor interest. Competing platforms with more efficient allocation mechanisms then go out of business, which eliminates comparison possibilities.

Privacy reduces cooperation, may be countered by free speech

Cooperation relies on reputation. For example, fraud in online markets is deterred by the threat of bad reviews, which reduce future trading with the defector. Data protection, specifically the “right to be forgotten” allows those with a bad reputation to erase their records from the market provider’s database and create new accounts with a clean slate. Bayesian participants of the market then rationally attach a bad reputation to any new account (“guilty until proven innocent”). If new entrants are penalised, then entry and competition decrease.

One way to counter this abusing of data protection laws to escape the consequences of one’s past misdeeds is to use free speech laws. Allow market participants to comment on or rate others, protecting such comments as a civil liberty. If other traders can identify a bad actor, for example using his or her government-issued ID, then any future account by the same individual can be penalised by attaching the previous bad comments from the start.

Of course, comments could be abused to destroy competitors’ reputations, so leaving a bad comment should have a cost. For example, the comments are numerical ratings and the average rating given by a person is subtracted from all ratings given by that person. Dividing by the standard deviation is helpful for making the ratings of those with extreme opinions comparable to the scores given by moderates. Normalising by the mean and standard deviation makes ratings relative, so pulling down someone’s reputation pushes up those of others.

However, if a single entity can control multiple accounts (create fake profiles or use company accounts), then he or she can exchange positive ratings between his or her own profiles and rate others badly. Without being able to distinguish new accounts from fake profiles, any rating system has to either penalise entrants or allow sock-puppet accounts to operate unchecked. Again, official ID requirements may deter multiple account creation, but privacy laws impede this deterrence. There is always the following trilemma: either some form of un-erasable web activity history is kept, or entrants are punished, or fake accounts go unpunished.

Committing to an experimental design without revealing it

Pre-registering an experiment in a public registry of clinical trials keeps the experimenters honest (avoids ex post modifications of hypotheses to fit the data and “cherry-picking” the data by removing “outliers”), but unfortunately reveals information to competing research groups. This is an especially relevant concern in commercial R&D.

The same verifiability of honesty could be achieved without revealing scientific details by initially publicly distributing an encrypted description of the experiment, and after finishing the research, publishing the encryption key. Ex post, everyone can check that the specified experimental design was followed and all variables reported (no p-hacking). Ex ante, competitors do not know the trial details, so cannot copy it or infer the research direction.

Avoiding the Bulow and Rogoff 1988 result on the impossibility of borrowing

Bulow and Rogoff 1988 NBER working paper 2623 proves that countries cannot borrow, due to their inability to credibly commit to repay, if after default they can still buy insurance. The punishment of defaulting on debt is being excluded from future borrowing. This punishment is not severe enough to motivate a country to repay, by the following argument. A country has two reasons to borrow: it is less patient than the lenders (values current consumption or investment opportunities relatively more) and it is risk-averse (either because the utility of consumption is concave, or because good investment opportunities appear randomly). Debt can be used to smooth consumption or take advantage of temporary opportunities for high-return investment: borrow when consumption would otherwise be low, pay back when relatively wealthy.

After the impatient country has run up its debt to the maximum level the creditors are willing to tolerate, the impatience motive to borrow disappears, because the lenders do not allow more consumption to be transferred from the future to the present. Only the insurance motive to borrow remains. The punishment for default is the inability to insure via debt, because in a low-consumption or valuable-investment state of affairs, no more can be borrowed. Bulow and Rogoff assume that the country can still save or buy insurance by paying in advance, so “one-sided” risk-sharing (pay back when relatively wealthy, or when investment opportunities are unavailable) is possible. This seemingly one-sided risk-sharing becomes standard two-sided risk-sharing upon default, because the country can essentially “borrow” from itself the amount that it would have spent repaying debt. This amount can be used to consume or invest in the state of the world where these activities are attractive, or to buy insurance if consumption and investment are currently unattractive. Thus full risk-sharing is achieved.

More generally, if the country can avoid the punishment that creditors impose upon default (evade trade sanctions by smuggling, use alternate lenders if current creditors exclude it), then the country has no incentive to repay, in which case lenders have no incentive to lend.

The creditors know that once the country has run up debt to the maximum level they allow, it will default. Thus rational lenders set the maximum debt to zero. In other words, borrowing is impossible.

A way around the no-borrowing theorem of Bulow and Rogoff is to change one or more assumptions. In an infinite horizon game, Hellwig and Lorenzoni allow the country to run a Ponzi scheme on the creditors, thus effectively “borrow from time period infinity”, which permits a positive level of debt. Sometimes even an infinite level of debt.

Another assumption that could realistically be removed is that the country can buy insurance after defaulting. Restricting insurance need not be due to an explicit legal ban. The insurers are paid in advance, thus do not exclude the country out of fear of default. Instead, the country’s debt contract could allow creditors to seize the country’s financial assets abroad, specifically in creditor countries, and these assets could be defined to include insurance premiums already paid, or the payments from insurers to the country. The creditors have no effective recourse against the sovereign debtor, but they may be able to enforce claims against insurance firms outside the defaulting country.

Seizing premiums to or payments from insurers would result in negative profits to insurers or restrict the defaulter to one-sided risk-sharing, without the abovementioned possibility of making it two-sided. Seizing premiums makes insurers unwilling to insure, and seizing payments from insurers removes the country’s incentive to purchase insurance. Either way, the country’s benefit from risk-sharing after default is eliminated. This punishment would motivate loan repayment, in turn motivating lending.

Putting your money where your mouth is in policy debates

Climate change deniers should put their money where their mouth is by buying property in low-lying coastal areas or investing in drought-prone farmland. Symmetrically, those who believe the Earth is warming as a result of pollution should short sell climate-vulnerable assets. Then everyone eventually receives the financial consequences of their decisions and claimed beliefs. The sincere would be happy to bet on their beliefs, anticipating positive profit. Of course, the beliefs have to be somewhat dogmatic or the individuals in question risk-loving, otherwise the no-agreeing-to-disagree theorem would preclude speculative trade (opposite bets on a common event).

Governments tend to compensate people for widespread damage from natural disasters, because distributing aid is politically popular and there is strong lobbying for this free insurance. This insulates climate change deniers against the downside risk of buying flood- or wildfire-prone property. To prevent the cost of the damages from being passed to the taxpayers, the deniers should be required to buy insurance against disaster risk, or to sign contracts with (representatives of) the rest of society agreeing to transfer to others the amount of any government compensation they receive after flood, drought or wildfire. Similarly, those who short sell assets that lose value under a warming climate (or buy property that appreciates, like Arctic ports, under-ice mining and drilling rights) should not be compensated for the lost profit if the warming does not take place.

In general, forcing people to put their money where their mouth is would avoid wasting time on long useless debates (e.g. do high taxes reduce economic growth, does a high minimum wage raise unemployment, do tough punishments deter crime). Approximately rational people would doubt the sincerity of anyone who is not willing to bet on her or his beliefs, so one’s credibility would be tied to one’s skin in the game: a stake in the claim signals sincerity. Currently, it costs pundits almost nothing to make various claims in the media – past wrong statements are quickly forgotten, not impacting the reputation for accuracy much. 

The bets on beliefs need to be legally enforceable, so have to be made on objectively measurable events, such as the value of a publicly traded asset. By contrast, it is difficult to verify whether government funding for the arts benefits culture, or whether free public education is good for civil society, therefore bets on such claims would lead to legal battles. The lack of enforceability would reduce the penalty for making false statements, thus would not deter lying or shorten debates much.

An additional benefit from betting on (claimed) beliefs is to provide insurance to those harmed by the actions driven by these beliefs. For example, climate change deniers claim small harm from air pollution. Their purchases of property that will be damaged by a warming world allows climate change believers to short sell such assets. If the Earth then warms, then the deniers lose money and the believers gain at their expense. This at least partially compensates the believers for the damage caused by the actions of the deniers.

Volunteer parking wardens may benefit the environment

Reducing the utility from car use and ownership motivates substitution towards other forms of transportation, which benefits both the environment and public health. One way to cut the convenience of driving is enforcing parking regulations, because drivers have to park further from their destination when the option of illegal parking becomes less attractive. Parking at a greater distance also makes people walk more – a minor health benefit.

Enforcing speed limits and other traffic rules that slow cars down increases the time cost of driving. This may reduce wear and tear on vehicles and roads, which benefits the environment.

An implication of is that people who want to reduce global warming or improve public health should become volunteer parking wardens and traffic police by reporting parking violations, speeding and dangerous driving (preferably with photo or video evidence from phones or dashboard cameras).

A possible countervailing effect of the enforcement of parking rules occurs if the illegally parked cars obstruct the movement of other cars enough to motivate some people to switch away from driving. Then stopping the parking violations may open the road up enough to encourage more use of cars, with an overall negative environmental and health effect. Similarly, if reckless drivers make the roads unsafe enough to reduce others’ car use, then making traffic civil again may attract risk-averse people back to driving. However, in most developed countries, illegal parking and the ignoring of rules of the road is not severe enough to deter driving significantly, so better enforcement is likely to reduce car use.

Slowing traffic down may increase congestion and emissions per kilometre travelled if there is little substitution away from driving. Again, in developed countries public transit and cycling are usually feasible options. Of course, some people always find excuses not to use these, and in remote rural areas public transit may indeed be economically unreasonable and distances may really be too great for bikes. Electric bikes are then an option. These increase the range of travel with less pollution and congestion than cars.

Platform providers fake being popular

Crowdfunding platforms, stock exchanges and other providers of two-sided markets want to appear popular, because having more buyers attracts more sellers and vice versa. The platform’s revenue is usually proportional to the number of users, because it charges a commission fee on trades or advertisers pay it to show ads to users. The exchange’s marginal cost of a user is close to zero, giving it an incentive to fake a high volume of trades, a large limit order book and a small bid-ask spread.

The platform’s cost of posting a great volume of outstanding buy and sell orders at a small spread is that many investors try to trade at these favourable bid and ask prices. Either the market maker has to take the other side of these attempted transactions or is found fraudulent. Taking the other side results in a large loss if some investors are better informed than the exchange.

The platform could falsely display a large trading volume, but keep the order book honestly small by adding fake trades at prices between the bid and the ask only, so no investor’s real limit order is ignored. This seems difficult to detect, unless one side of the limit order book is empty (e.g. no buyers) and at least one at-market order on the other side (e.g. a sell) is outstanding. In this case, any trades occurring would have to satisfy the at-market order. However, the platform or real investors can then take the other side of the at-market order at a very favourable price to themselves, which discourages at-market orders. A large trading volume with a thin order book is still slightly suspicious, because it requires that crossing buy and sell orders between the bid and ask prices arrive almost simultaneously, in order to be matched without appearing on the order book for long, and without triggering the real limit orders. Displaying the fake buys and sells on the order book risks attracting actual matching trades, which the platform would have to honour (at a cost).

Without automated quote matching, there are no at-market orders, for example on the Funderbeam crowdfunding platform. Instead, everyone either posts a limit order or picks an order from the other side to trade with, e.g. a buyer chooses a sell. Investors can pick an order with a worse price (higher sell or lower buy) on the other side, which frequently occurs on Funderbeam. Choosing a worse price is irrational, unless the traders in question are colluding, so the asset is effectively not changing ownership. Reasons to carry out such seemingly irrational trades are to manipulate price and volume, e.g. price can be raised or reduced by targeted trades outside the bid-ask interval. Volume can only increase after added trades, rational or not, but such seemingly greater activity is exactly what benefits the stakeholders of the platform. The employees of the market maker have a natural motive to fake-trade between themselves to make their firm look good, even without any inappropriate pressure from their boss.

Another way to attract issuers and investors is to demonstrate successful initial public offerings, meaning that the funds are raised quickly (good for issuers) and the price of the newly listed stock (or other asset) goes up, which benefits investors. Adding fake capital-raisers is difficult, because potential investors will check the background of the supposed issuer. Inserting spoof investors into an actual funding campaign is costly, because real money would have to be invested. One way to manipulate popularity upward is to simultaneously add a fake issuer and fake investors who satisfy its funding need. The idea is to not leave time for real investors to participate in the campaign, by pretending that the capital-raiser achieved its target funding level before most investors could react. This is easier in markets with a small number of real investors and without an auto-invest feature. However, the real investors who were supposedly pre-empted may still research the supposedly very popular issuer.

A costless way to briefly boost the popularity of a real fundraising campaign is to add fake investors after the target funding is achieved, and forbid issuers from increasing the target or accepting funds from those who subscribed after the goal was reached. Any campaign meeting its target can then be made to look heavily oversubscribed. However, if the issuers are informed in advance of the restriction not to increase the target, then they may find an alternative unrestricted platform to raise funds. On the other hand, if the restriction is not mentioned beforehand, then it will likely anger the issuers who will then create negative publicity for the platform. Competition between exchanges thus curtails their manipulation incentives.

The platform can motivate real investors to raise their bids when the campaign reaches its target by rationing demand: bidders in an oversubscribed share issue get only a fraction of what they wanted to buy. Anticipating this, buyers will increase their requested quantities so that the fraction of their new bid equals their actual demand. This makes the campaign look oversubscribed and creates a feedback loop: if other investors increase their quantities, then rationing reduces the fraction of a given investor’s demand that will be satisfied, so this investor raises her or his requested amount, which in turn makes others increase theirs.

If investors know of the bid rationing in advance, then they may select a rival market provider without this restriction, but if rationing takes them by surprise, then they may leave and publicly criticise the platform. Capital-raisers compare exchanges, so if many market providers inflate demand and the issuers pay attention to the level of oversubscription (instead of the fraction of campaigns reaching the target, which is what should matter to the capital-raiser), then the biggest inflator wins. Of course, platforms may not want to reveal unsuccessful campaigns (e.g. Funderbeam does not), so public data on the fraction of issuers who achieved their funding goal is unlikely to exist.

Theoretically, the feedback from bid rationing to increased quantity demanded could lead to infinite amounts requested. A countervailing incentive is that with positive probability, other investors do not honour their commitment to buy, in which case a given investor may be required to buy the amount (s)he demanded, instead of the lower amount (s)he actually wanted. If there is no commitment to buy (for example, on Funderbeam the bids are only non-binding indications of interest), then the danger of overcommitting is absent, so the rational choice seems to be requesting an infinite amount. Investors do not indicate infinite interest, so either they are irrational or some other penalty exists for outbidding one’s capability to pay.

Star job candidates benefit from appearing to be worse

Employers have a cost of making a job offer: filling out forms, getting approval, not being able to make other offers simultaneously in case too many job candidates accept, etc. A company who believes that it is not the top choice of candidates would want to avoid making an offer to a star applicant (one who is likely to receive better alternative offers from top employers, thus turn down the lower-ranked company’s offer).

If the star job-seeker is uncertain about the offers she or he will get, or wants a bargaining chip to use with the most preferred company, then (s)he prefers to obtain the lower-ranked employer’s offer, even when planning to reject it. A way to entice the company into offering a job is to pretend to be more attainable (have a worse outside option) by faking lower talent and potential when interviewing with lower-ranked employers. For this pretence to be (partly) credible, it must have a cost for the job-seeker, otherwise all the best candidates would pretend to be worse and increase their chance of obtaining offers from their backup employers. Then the next-best candidates would have to fake being less good to receive jobs, etc. This race to the bottom would only end once all candidates look like the worst possible, which does not seem realistic.

One potential cost is that faking lower talent has a random outcome, which may be so bad that the employer does not want to offer a job at all. This would temper the incentive to appear worse. Another cost is information leakage – if bad performance at a less desirable interview becomes known to higher-ranked employers, then the candidate may forfeit her or his most preferred interviews and jobs. It could also be that the top job-seekers cannot hide their quality, for example because their genius shines out despite their best effort, or employers base offers solely on recommendation letters, which the candidate cannot see or affect around the time of applying.