We examine equilibria in competitive insurance markets with adverse selection when wealth differences arise endogenously from unobservable savings or labor supply decisions. The endogeneity of wealth implies that high risk individuals may ceteris paribus exhibit the lower marginal willingness to pay for insurance than low risks, a phenomenon that we refer to as irregular-crossing preferences. In our model, both risk and patience (or productivity) are privately observable. In contrast to the models in the existing literature, where wealth heterogeneity is exogenously assumed, equilibria in our model no longer exhibit a monotone relation between risk and coverage. Individuals who purchase larger coverage are no longer higher risks, a phenomenon frequently observed in empirical studies.
In a pioneering approach towards the explanation of the phenomenon of “yes man” behavior in organizations, Prendergast [American Economic Review 83 (1993) 757–770] argued that incentive contracts in employment relationships generally make a worker distort his privately acquired information. This would imply that there is a trade-off between inducing a worker to exert costly effort and inducing him to tell the truth. In contrast, we show that with optimally designed contracts, which we term integrity contracts, the worker will both exert effort and report his information truthfully, and hence the first best can be achieved.
Strong reciprocity is characterized by the willingness to altruistically reward cooperative acts and to altruistically punish norm-violating, defecting behaviours. Recent evidence suggests that subtle reputation cues, such as eyes staring at subjects during their choices, may enhance prosocial behaviour. Thus, in principle, strong reciprocity could also be affected by eye cues. We investigate the impact of eye cues on trustees' altruistic behaviour in a trust game and find zero effect. Neither the subjects who are classified as prosocial nor the subjects who are classified as selfish respond to these cues. In sharp contrast to the irrelevance of subtle reputation cues for strong reciprocity, we find a large effect of explicit, pecuniary reputation incentives on the trustees' prosociality. Trustees who can acquire a good reputation that benefits them in future interactions honour trust much more than trustees who cannot build a good reputation. These results cast doubt on hypotheses suggesting that strong reciprocity is easily malleable by implicit reputation cues not backed by explicit reputation incentives.
