1. Promises, Reliance and Psychological Lock-In Rebecca Stone & Alexander Stremitzer IMPRS Jena, July 28

2. Legal Enforcement of Promises Conventional account: Legal system enforces promises because otherwise… – promisors would opportunistically break promises. – Anticipating this promisees would under-rely. Treating this under-investment result as a benchmark, the question then becomes which remedy leads to better investment incentives (Shavell 1980, 1984; Rogerson 1990; Edlin & Reichelstein 1994,...). – Typically, the legal regime runs the risk of leading to overinvestment.

3. Legal Enforcement of Promises Legal enforcement facilitates exchange and production by allowing people to commit to a future course of action.

4. Alternative Sources of Commitment Reputational concerns - literature on relational contracting (Macaulay 1963, Klein & Leffler 1981, Baker, Gibbons & Murphy 1994, Levin 2003,...) – Allows promisors to commit to a future action in repeated interactions (but not in a one-shot interaction.)

5. Alternative Sources of Commitment Moral force of promise keeping (Ellingsen & Johannesson 2004, Charness & Dufwenberg 2006, Vanberg 2008, Ederer & Stremitzer 2015...) – Classic Game Theory: Mere cheap talk. No commitment, no reliance investments. – Guilt Aversion: Creates commitment power, positive investment incentives in the absence of legal enforcement (also in one-shot interaction.)

6. Promissory Lock-in If reliance affects a promisor’s guilt from breaking his promise, we would predict that – Promisors more inclined to keep promises that have been relied upon. If promisees anticipate this, we would predict that – Promisees overinvest in order to encourage promisors to keep their promises (“psychological lock-in”)?

7. Effect of the Legal Regime Legal enforcement might therefore – Reduce overinvestment as promisees no longer have to rely on the extra-legal mechanism of locking in the promisor (by overinvesting). – But, might also reduce cooperation when the legal regime is not triggered (crowding out).

8. Legal Regime We study legal enforcement that resembles a promissory estoppel regime. – Enforcement of promises that have been detrimentally relied upon. – Discretion between ED and RD. – In this paper, we focus on ED.

9. Player A Don’t Send Money Send Money A gets 12 B gets 12 A gets 15 B gets 6 Design The Modified Dictator Game

10. Player B Player A B’s investment = i Don’t Send Money Send Money A gets 12 B gets 12 if i = 0 12.50 – 0.25i if i > 0 A gets 15 B gets 6 – i 0 1 2 3 4 56 Design The Modified Dictator Game

11. Design Treatments: – No Regime: No enforcement; subjects can make promises to one another. – Expectation Damages: A has to compensate B if she breaks a promise upon which B relied by paying B Expectation Damages.

12. Did A send money to B? AB 012 1 12.25 212 3 11.75 41211.50 51211.25 61211 Did A make a promise? AB 0156 1 5 2 4 3 3 4 2 5 1 6 0 AB 0 6 1 5 2 4 3 3 4 2 5 1 6 0 YesNo Payoffs under No Regime

13. Did A send money to B? AB 012 1 12.25 212 3 11.75 41211.50 51211.25 61211 Did A make a promise? AB 0156 1 5 2 4 3 3 4 2 5 1 6 0 AB 0 6 1 5 2 4 3 3 4 2 5 1 6 0 YesNo Payoffs under No Regime

14. Did A send money to B? AB 012 1 12.25 212 3 11.75 41211.50 51211.25 61211 Did A make a promise? AB 0156 1 5 2 4 3 3 4 2 5 1 6 0 AB 0 6 17.7512.25 2712 36.2511.75 45.5011.50 54.7511.25 6411 YesNo Payoffs under Expectation Damages

15. Did A send money to B? AB 012 1 12.25 212 3 11.75 41211.50 51211.25 61211 Did A make a promise? AB 0156 1 5 2 4 3 3 4 2 5 1 6 0 AB 0 12 17.7512.25 2712 36.2511.75 45.5011.50 54.7511.25 6411 YesNo Payoffs under Expectation Damages

16. Strategy Method and Belief Elicitation We used the strategy method for A’s choice: – A had to indicate whether or not she would send money to B for every possible investment level; – A’s actual choice (and so final payoffs) was determined by the choice she made for the investment level actually chosen by B. We also elicited B’s beliefs about A’s actions: – Prior to making his investment decision, B had to indicate his level of confidence that A would send him money for each possible investment level.

17. Procedure Experiments were conducted at Xlab (Berkeley) and EBEL (UCSB). Between-subject design: each subject participates in only one treatment. 70 subjects per treatment. In each treatment: – Subjects play 8 rounds of the experiment (after 2 practice rounds). – Each subject is randomly matched with a new subject at the beginning of each round.

18. Procedure Earnings: – One round was randomly selected for payment based on the subjects actions in this round. Average earnings = $11.55 – A different round was randomly selected for payment based on B’s guesses about A’s actions Average earnings = $2.19 – Subjects also earned a $5 show-up fee and payment for some post-experiment questions.

19. Results: Positive Cooperation in Absence of Legal Regime Dictators cooperate 40% of the time in No Regime. Average investment is 1.04 in No Regime. Contrary to the predictions of Classic Game Theory

20. ED generates superior investment decisions than No Regime NOTE: less overinvestment Results: Investment Decisions

21. Results: Average Overinvestment ED generates lower average overinvestment than No Regime: 2.3 versus 3.3.

22. Results: Psychological Lock-In Dictators cooperate more as investment increases and Recipients anticipate this

23. Results: Cooperation ED generates more cooperation than No Regime.

24. Results: Promises Made Introducing a Legal Regime reduces the numbers of promises

25. Crowding Out The legal regime crowds out cooperation when a promise is made and investment is zero.

26. Crowding Out Recipients anticipate this crowding out

27. Results: Joint Payoffs Legal Regime with ED generates higher joint payoffs.

28. Results: Payoff Differentials Legal Regime ED generates the lowest payoff differentials between participants

29. Conclusions Absent Legal Enforcement: – Promisors are more inclined to keep promises that have been relied upon. – Promisees anticipate this effect: Beliefs: Positive relationship between reliance and cooperation. Actions: Overinvestment. – Consistent with “psychological lock-in”.

30. Conclusions Introducing the Legal Regime – ED generates superior investment decisions. Surprisingly, reduces overinvestment – ED improves overall cooperation rates. – Downside: ED crowds out voluntary cooperation when legal regime is not triggered. However, since Recipients anticipate this, it doesn’t have a large effect on aggregate welfare.

31. Implications Reliance matters for promise keeping. To the extent that law tracks our moral intuitions, reliance should be legally relevant in deciding whether to enforce. Legal regimes may crowd out (inefficient) extra-legal enforcement mechanisms. Crowding out extra-legal mechanism is not necessarily a bad thing: ED gives promisees a more fine-tuned tool to lock in the promisor.

32. Appendix

33. A will certainly send B money A will probably send B money There is a 50-50 chance that A sends B money A probably will not send B money A certainly will not send B money B’s earnings if A decides to send him money $0.65 $0.60 $0.50 $0.35 $0.15 B’s earnings if A decides not send B money $0.15 $0.35 $0.50 $0.60 $0.65 Elicitation of B’s Beliefs

34. Participant 1 Participant 2 “I promise to send $ if you promise me back” “I don’t promise” “I promise” Both 1 & 2 have promised Neither 1 nor 2 have promised Only 2 has promised Design: The Communication Phase

35. Freeform Design Alternative Design: – subjects to freely communicate during the Communication Phase; – a panel of three other subjects evaluate the conversations to determine whether promises were made. Problem: subjects coordinate on the investment decision, so any lock-in effect seems to disappear. [Question: We see less overinvestment under RD—remedies less relevant when trust develops?]

36. Promise-Making Over Time

37. Investment Over Time

39. Cooperation Over Time

41. Joint Payoffs Over Time

43. Did A send money to B? AB 012 1 12.25 212 3 11.75 41211.50 51211.25 61211 Did A make a promise? AB 0156 1 5 2 4 3 3 4 2 5 1 6 0 AB 0 6 1146 2136 3126 4116 5106 696 YesNo Payoffs under Reliance Damages

44. Did A send money to B? AB 012 1 12.25 212 3 11.75 41211.50 51211.25 61211 Did A make a promise? AB 0156 1 5 2 4 3 3 4 2 5 1 6 0 AB 0 6 1146 2136 3126 4116 5106 696 YesNo Payoffs under Reliance Damages