Economics meets Applied Psychology Mana Komai Economist John

Economics meets Applied Psychology Mana Komai (Economist) John Kulas (Psychologist)

Outline • Definitions • Introduction to basic concepts • History • Economics • Collaboration • How we can work together • Example • Project focused on ethics and leadership • Applications • Relevance to business (help!) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Game Theory DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Analysis of strategic behavior among rational players • Rational players can be firms, consumers, countries, political agents • Can be applied to organizational behavior, market behavior, evolutionary biology, business strategies, contracts

I/O Psychology • Application of Psychology principles, methods, and theories to work applications • can be applied to the selection of employees, training, performance evaluation, motivation DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Experimental Economics • Experimental economics is the application of experimental methods to study economic questions • Do sequential (visible) contributions to charities increase total contributions? • Do different wage schemes effect job performance?

Behavioral Economics • Effects of Psychological factors on economic decision making • Why do some consumers make irrational purchases (for example, big screen TV when they can’t afford [on credit])? DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

An important assumption in classical economics • People are rational, selfish, utility maximizing economic agents • Complicated psychological traits do not much matter to a classical economist DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Power of economic prediction depends on assumptions • Our theoretical results and predictions highly depend on these assumptions • We did not question ourselves much for a while, until… DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

The emergence of experimental economics DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Experiments in economics were introduced in the 1960 s and 1970 s • Mainstream economists began to acknowledge their relevance in 1980 s • Game theory • Public choice theory • Industrial organization theory • Information economics • Financial economics

DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Results from economic experiments went against so many predictions which were highly dependent on our rigid “we are all rational, selfish, economic robots” assumption • Led to alternative theories • Sometimes people do some decisions based on, for example, rules of thumb

Economists started to talk about: • Bounded rationality • Altruism • Warm glow • Trust • Appreciation for fairness • Inequality aversion • Envy • Reciprocity DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

We can work well together: • In 2002 a Nobel prize in experimental economics was shared by Vernon Smith (an economist) and Daniel Kahneman (a psychologist) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Our collaboration • Mana’s work is on organizations and leadership – Mana thought as a psychologist, John could contribute, John thought Mana could provide a solid mathematical framework to the study of organizational issues • We started working on leadership and organizations • Game structure based on a previous paper (Komai & Stegeman, 2010) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Problems/Friction DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Very few economics articles discuss leader characteristics • At first only “risk aversion” allowed by Economists • Now “Ethics” permitted • Risk aversion was more of an economics construct (economists pay attention to it)

An Example of Collaboration Leadership and Ethics Mana Komai Philip Grossman John Kulas DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Ethical Leadership • Modeling and promotion of morally appropriate behavior (Brown, Treviño, & Harrison, 2005) • Applied and academic interest following ethical scandals of early 2000’s (Enron, Worldcom, Tyco) • Always 1 measured with field samples (Ng & Feldman, 2014) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS We investigate whether followers’ perceptions of leaders’ ethics can affect group behavior in a collective action game in which leaders can privately benefit from deceiving their followers

The collective action game • 3 players • Each player decides whether or not to invest in a group investment project • Two possible projects, which are equally likely to happen • Payoffs are shown on the next page: DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Payoffs Project 1 Project 2 Invest Not invest (each) All invest 20 _ 13 _ 2 invest 13 17 9 15 1 invests 7 14 5 12 No one invests - 10

Efficient outcome (what is good for the group) • All group member should invest in the project DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

The predicted outcome (the Equilibrium) • In Project 1: either all 3 invest or nobody does • In Project 2 nobody invests DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • The predicted problem in Project 1 is called the “coordination problem” • The predicted problem in Project 2 is called the “freeriding problem” • In this collective action game, both problems can hinder “efficient” group cooperation

Leadership Structure DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • One player is chosen randomly to be the leader. • The leader observes which project is assigned to his/her group • The other two players (followers) do not. In other words, the leader has exclusive access to critical information

The leader moves first, making two separate but simultaneous decisions. • Investment (not observable or verifiable by followers) • Suggestion (observable by followers) • Followers observe the leader’s suggestion and decided simultaneously whether or not they want to invest DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

The predicted outcomes (the equilibrium) • Either nobody invests. • The leader invests in Project 1 but not 2 and followers invest • The leader’s suggestion is not costly for him/her. Thus, the leader may very well choose to deceive his/her followers in project 2

Predictions • A leader’s personal characteristics (including his/her ethics) plays no role in the economic analysis of the outcomes

Psychological twist • In this game, the leader has an incentive to deceive his followers by suggesting a course of action, which he/she may decide not to follow • You would think a leader’s ethics may matter DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Let us see DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Whether information about a leader’s ethics would affect the final outcome of the game Whether information about a leaders’ ethics impacts which equilibrium is more likely to happen Whether information about a leaders’ ethics impacts the occurrence of the efficient outcome

The Experiment DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Student subjects from Monash University participate in the experiment • The experiment takes place in the MONLEE lab with fully partitioned workstations and is conducted with computers running a z-Tree program

Leaders and followers • In each group, one player is chosen randomly to become the first mover or the Type A player (the leader) • The other two players are second movers or Type B players (followers) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Two experimental treatments • Treatment 1: Ethical information about the leaders results are left out • Treatment 2: Followers make their investment decisions after they are informed of their leader’s ethical standing DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Treatment 2 classification DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS • Followers are informed that the leader’s score placed him/her in the lower 1/3, middle 1/3, or upper 1/3 compared to a sample of 184 university students who previously completed the 15 -item survey

Leader action • The leader makes both an actual investment decision and an invest/not invest recommendation for both possible projects • The recommendation does not have to reflect the leader’s actual decision • One of the two projects is then randomly selected for the group and the leader’s invest/not invest recommendation is passed to her followers DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

(Preliminary) results Subjects who invested Scenario 1 20 out of 33 Treatment 1 (60%) Scenario 1 26 out of 42 Treatment 2 (62%) Scenario 2 28 out of 47 Treatment 1 (60%) Scenario 2 16 out of 37 Treatment 2 (43%)

(Preliminary) results Leaders who invested Leaders who suggested an Leaders who deceived investment decision (investment<suggestion) Scenario 1 21 out of 26 24 out of 26 3 out of 26 Treatment 1 (% 81) (% 92) (% 11) Scenario 1 19 out of 27 27 out of 27 8 out of 27 Treatment 2 (% 70) (% 100) (% 30) Scenario 2 10 out of 26 19 out of 26 Treatment 1 (% 38) (% 73) (% 35) Scenario 2 2 out of 27 21 out of 27 19 out of 27 Treatment 2 (% 7) (% 78) (% 70)

(Preliminary) results Treatment 1 Treatment 2 Followers who invested Followers who mimicked the leaders’ decisions 28 out of 49 36 out of 49 (% 57) (% 74) 33 out of 57 39 out of 57 (% 58) (% 68)

(Preliminary) results • Leaders are 30% more likely to deceive their followers in Treatment 2, where leaders’ ethical category is revealed to their followers • Being introduced as a highly ethical leader to their followers makes them 31% more likely to deceive their followers for their own advantage (and not the benefit of their group) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Implications • Followers are much more likely to follow leaders who are introduced to them as highly ethical compared to the ones categorized in the lowest ethical category in Treatment 2. DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Relevance to Business • Moving forward – where the future of behavioral and experimental economics is in respect to business (e. g. , how it can help) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Behavioral economists acknowledge: • bounded rationality (i. e. the adoption of “rules of thumb”) • limited self-control (i. e. buying that flat screen TV today on credit, rather than saving for it or having that slice of cheesecake for dessert even though you know you need to lose 10 pounds) • bounded selfishness (i. e. giving to charities or helping a stranger) DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS Unrealistic assumptions of rational man model: unbounded rationality (the ability to process unlimited information and solve problems optimally) unbounded willpower (the ability to forgo impulse purchases) unbounded selfishness (care only about own wellbeing)

Real-world relevance • How to get people to contribute more (time/money) to public goods/charitable foundations • Signing up for voluntary training • Participation in health & wellness initiatives • Contextual Performance DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS

Other applications? Any behavioral change application with relaxed rational man assumptions… DEFINITIONS HISTORY COLLABORATION EXAMPLE APPLICATIONS