Conformism, peer pressure and adverse selection

Abstract

To examine the effects of peer pressure in adverse selection problem, we define a peer pressure function that represents the psychological costs and incorporate it into the agent's utility function. Based on these assumptions, the efficient agent who has conformity preference produces less outputs than the first-best level, while the inefficient agent produces more than the second-best level of standard adverse selection output when the agents feel peer pressure among themselves. Although the production gap between the utility functions under peer pressure narrows, the gap of the ex post information rent goes wider as the information rent of efficient agents increases. Our theoretical results are consistent with some empirical/experimental findings.

Notes

¹ Hehenkamp and Kaarboe (2006) generally investigate the effect of peer pressure in teams with more than two agents who are risk neutral but heterogeneous in productivity. Daido (2004, 2006) also consider more specific peer pressure function than Hehenkamp and Kaarboe's (2006) model.

² In Huck et al. (2002), agents are concerned about adherence to a social norm which emerges endogenously. However, in Huck et al.'s (2002) model, multiple equilibria exist: choose high (respectively low) effort if others work more (respectively less).

³ Fehr and Schmidt (1999) develop a model in which a person exhibits inequity aversion if he incurs disutility both from being worse off in material terms than the others and from being better off. The conformism and the form of inequity aversion do not necessarily coincide.

⁴ Huck and Rey Biel (2006) justify with ‘conformity preferences.’ Their setting focuses on that agents only care about choosing similar efforts.

⁵ As we will understand the proof of Proposition 1, its assumption needs to reveal agents’ type truthfully.