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The Effects Of Anchoring Heuristics In Bargaining Games

Mason Lusk

Valdosta State University 2013

2 1. Introduction Classical economic models conjecture that emotions and social norms do not matter. When assuming that people are rational, game theory makes mathematically sound and accurate behavioral predictions. However, a wealth of experimental and behavioral economics literature, some of which is explored in this paper, assert that emotions and social norms certainly do matter. These effects are notoriously difficult to quantify. This paper intends to give insight into how we can design methods to quantify behavioral effects on market outcomes, which we can then use to build better models. In doing so I will also explore another question: does empathy exist in economics and what is its place? Experiments have shown that emotions and social norms like spite and fairness have an effect on market outcomes but what effect does empathy have? I hope to answer that question with experimental methods and using a simple bargaining game. When I refer to empathy I am using the definition from the Merriam-Webster dictionary:
The action of understanding, being aware of, being sensitive to, and vicariously experiencing the feelings, thoughts, and experience of another of either the past or present without having the feelings, thoughts, and experience fully communicated in an objectively explicit manner; also: the capacity for this

The game used in this paper is derivation of the ultimatum game, which was first used by Gth et al. (1982). There are two players in this game. The first sequential player is a proposer. Their role is to choose one of two possible options as a split of an allotted number of extra credit points. The second sequential player is a responder. Their role is to decide whether to accept the proposed split of extra credit points or to reject it. If the responder rejects the proposers offer, both players receive zero extra credit points. The rate of rejection for low offers between two different treatments is compared. By keeping payoffs positive and assuring that the disparity of the outcomes is the same in two different scenarios I can isolate what effect the perception about other peoples behavior has on market outcomes in ultimatum bargaining situations. I hope to elicit empathy from responders by taking advantage of a cognitive bias called anchoring. Anchoring causes people to draw unsubstantiated conclusions by using contextual information available to them. The results from the experiment are analyzed using regression analysis and another statistical test, the Fishers exact test. Finally, I will end with possible implications of the experimental results as well as some suggestions for future research. 2. The Classical Approach In treatment one, the control treatment, a proposer may either offer a split of five extra credit points for themselves and one extra credit point for the responder (5,1) or they may offer a split of three extra credit points for themselves and three extra credit points for the responder (3,3). The extended form representation for treatment one is shown in figure one.

Figure 1

Accept 5,1 Reject

3,3

Accept

Reject Analyzing the possible endgame outcomes with the notion that players are rational, we expect that responders will accept any offer because it yields positive payoffs. The proposer will expect the responders rational behavior and select their proposal accordingly. Since the proposer expects the responder to be rational and accept any offer, the Proposers best move is to maximize their payouts. In this treatment that means choosing a split of 5,1 over a split of 3,3. The game theoretical predicted outcome for this game is that proposers, as first players, will choose the 5,1 split and then responders, as second players, will accept the offer. Both players will have maximized their payouts given their possible options and subgame perfect Nash equilibrium is achieved. In treatment two, the experimental treatment, a proposer may either offer a split of five extra credit points for themselves and one extra credit point for the responder (5,1) or they may offer a split of one extra credit point for themselves and five extra credit points for the responder (1,5). The extended form representation for treatment two is shown in figure two.

Figure 2 Accept 5,1 Reject

1,5

Accept

Reject

Once again we expect that if responders are rational that they will accept either offer because they both produce positive payouts. The proposers best move is to make the 5,1 proposal. The game theoretical predicted outcome for this game is that proposers, as first players, will choose the 5,1 split and then responders, as second players, will accept the offer. Both players will have maximized their payouts given their possible options and subgame perfect Nash equilibrium is achieved. This illustration is accurate for depicting rational behavior, as early economic game theory would predict, but the experiments performed by Gth et al. and others show that this is not how participants in this game actually behave. 3. A History of The Ultimatum Game Something interesting happens in the experiment performed by Gth et al (1982). Actual offers do not reflect the offers that theory predicted would occur. The first time participants played the game the 21 proposers, or givers as they are referred to in the experiment, offered a mean of 37 percent of their allotted chips to responders, who are referred to as receivers. Also worth noting is that a third of proposers offered an equal split. Only one proposal was rejected. When experimenters later convened a second trial with the same participants, lower offers were made but more rejections also occurred. Only two out the 21 proposers offered an equal split and the mean offer decreased to about 32 percent. Responders rejected five offers in the second trial as opposed to the single rejection in the first trial.

4. Determinants For Market Outcomes In Ultimatum Games Since the first ultimatum game performed by Gth et al., economists and other social scientists have tried to determine why the behavior deviates from game theory predictions. While positive payoffs do matter they are not the only things that matter. Fehr and Schmidt(1999) hypothesized that behavior is not only determined by material payoffs but also by a sense of fairness about the outcomes:

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Inequity aversion means that people resist inequitable outcomes; i.e., they are willing to give up some material payoff to move in the direction of more equitable outcomes. Inequity aversion is self-centered if people do not care per se about inequity that exists among other people but are only interested in the fairness of their own material payoff relative to the payoff of others (pg 819).

People will look at the size of their payoffs and compare them to the payoffs of others. The theory of inequity aversion asserts that if these payoffs are different from some culturally determined reference point of fairness then people will give up material value to move towards a more equitable outcome (Fehr & Schmidt, 1999). Another ultimatum game experiment by Kahneman, Knetsch, and Thaler found that when a proposer is asked to make an offer to divide an amount of money that 76 percent of proposers offer about half (1986a). Even more interesting is that participants were willing to decrease their own payoffs to punish a player who made an unequal offer to someone else (1986a). Falk and Fischbacher (2006) suggest that the cause of rejections is the result of reciprocity. The theory posits that responders in the ultimatum game reject offers only when they feel that the proposer has behaved unfairly. Rejection is a way of punishing antisocial behavior and proposers make more equal offers to avoid rejection. This is evident in certain experiments using a dictator game. A dictator game is a derivation of the ultimatum game where in the first player decides how to divide the payoffs between herself and another player without the other player being able to reject the offer. Hoffman, McCabe, and Smiths 1996 paper Social Distance And Other Regarding Behavior In Dictator Games (as cited in Hoffman, McCabe, & Smith, 2008a) found that by increasing social distance of players, dictators made more self-regarding offers. This suggests that generous offers may also be explained, in part, by proposers fear of punishment for violating social norms (Hoffman, McCabe, & Smith, 2008a). In Preferences And Property Rights In Ultimatum And Dictator Games Hoffman, McCabe, & Smith (2008b) find that when participants earn the right to be a proposer or a dictator through a general knowledge quiz, their offers become less generous and more self-regarding. Responders also accept lower offers when the roles in which participants are placed are the result of their own actions (Hoffman, McCabe, & Smith, 2008b). These findings convey that unfair offers become more acceptable because the proposers behavior is justifiable when they earned the right to make unfair offers. When participants are randomly assigned roles and proposers are asked to split a sum of money with their respective responder they tend to be more otherregarding in nature and their offers move closer to the center (Hoffman, McCabe, & Smith, 2008b). In this situation proposers have earned no right to exploit the advantage of their first mover position. Thus, responders may reject the proposers more selfish offers because they violate terms of their social contract (Hoffman, McCabe, & Smith, 2008b). Behavior that deviates from the norm may be reciprocated by the responder in the form of a rejection. Some proponents of these theories suggest they are mutually exclusive but burgeoning neuroscience research indicates that both are true and that both matter. It is important to note the processes involved in determining the effects of inequity aversion and reciprocity decisions are interconnected but independent of each other. A variety of neuroscience studies suggest this. Tricomi et al (2010) found results that support the theory that fairness of offers matter and they localize this activity in the brain. This was demonstrated in a simple experiment with men who were set in pairs. One participant received 50 dollars at

6 the beginning of the experiment and the other participant received nothing. The experiment moderator then made transfers of money to the participants independently. Participants were then asked to rate the transfers. Participants rated transfers to themselves positively. The high pay participants that received the 50 dollars at the beginning positively rated the transfers to the low pay participants that received no money. However, the low pay participants negatively rated the transfers made to high pay participants even though these transfers have no effect on their own payoffs. Functional magnetic resonance imaging (fMRI) data from participants show that at the time the offers are made to the other participant in a pair that increased activity in the ventromedial prefrontal cortex (vmPFC) occurs. These findings are consistent with other neuroscience literature that suggests that the vmPFC is the area of the brain most associated with perceiving how outcomes and consequences affect ones self. Another brain region called the right temporoparietal junction (rTPJ) activates when people are thinking about other peoples behavior. Young and Saxe (2009) use a simple experiment to demonstrate when the rtpj is used and what triggers it. Some participants are given a simple anecdote about two different scenarios with the same outcome. The first scenario is: Grace and her friend are on a tour of a chemical factory. When Grace goes over to the coffee machine to pour some coffee, Graces friend asks for some sugar in hers. There is white powder in a container by the coffee. The white powder is regular sugar left by the kitchen staff. The container is labeled sugar so Grace believes that substance is regular sugar. Grace puts the substance in her friends coffee. Her friend drinks the coffee, and is fine. (pg.2066) The second scenario is different in only one way: ...The container is labeled toxic so Grace believes that the white powder is a poison. Grace puts the substance in her friends coffee. Her friend drinks the coffee, and is fine. (pg.2066) In both scenarios the substance is sugar and when her friend drinks it nothing happens. However, Graces belief about the substance is different. After hearing the two scenarios, participants rate how much blame Grace deserves. The ratings show that participants believe that Grace deserves more blame when she thinks the substance is poison and puts it in her friends drink although in both scenarios the outcomes are the same. Some participants also hear a scenario where the white substance is actually a poison but is labeled as sugar. In this scenario Grace thinks the substance is sugar and her friend dies. Participants say that Grace deserves less blame in this scenario than in the scenario where she thinks the sugar is poison and nothing happens to the friend. Results from fMRI feedback while participants are considering how much blame Grace deserves show the primary region of interest in the brain is the rTPJ. For responders, the decision to accept or reject an offer is a function of their strategic value and their normative value. Strategic value is the result of the strategic behavior that game

7 theory would predict, that players look at their offer and consider if it is greater than zero. The second half of the equation is the normative value of the offer, which is a measure of the responders notions about fairness. The notions of fairness can be further broken down into two halves. The first is a measure of how fair the responder thinks the offers outcomes are. The second component of normative value is how fair the responder thinks the behavior of the proposer is. I believe by manipulating a single aspect of the ultimatum game we can affect how responders view the fairness of the proposers behavior and lower rejections. In the Young and Saxe experiment the participants making judgments about the behavior of others had a key piece of information: They knew the internal intentions of the person whose behavior they were judging. In the conditions of treatment two of the experiment used in this paper the responder does not know whether the proposer chose the 5,1 split to be selfish or if they value fairness but chose the 5,1 split to avoid an equally unfair but disadvantageous 1,5 split. This uncertainty is key. I expect that in the absence of the possibility of equitable outcomes the responder will experience something like empathy and justify the proposers choice of a 5,1 split by assuming the proposer made the offer because their hands were tied and not because they think the proposers behavior is selfish. I believe this is due to the presence of the 1,5 offer as possibility on the form. This option serves as a cue that might prompt the responder to assume that the intentions of the proposer are less nefarious even though there is no evidence present to support this. This possibly the result of something like a cognitive bias called anchoring. 5. Anchoring As A Determinant Of Reciprocal Behavior In the ultimatum game the simple presence of a fair, equal choice in the array of the proposers possible choices may affect the participants behavior. It is my expectation that responders consideration to reject of the same 5,1 offer across treatments is affected by the other possible offer. I believe this is due to anchoring. This effect may manifest itself in the way responders gauge proposers behavior by assessing available information to fill in gaps in perception. In treatment one, responders may compare the 5,1 split to the other possible 3,3 split which evokes a social norm of fairness and they may punish the other player for violating a social norm rather than accept the 1 extra point as a payout in a market transaction. However, in treatment two, responders may compare the 5,1 split to a split of 1,5 and may assess them as more acceptable thus making fewer rejections. Anchoring is a cognitive bias that was first explored by Amos Tversky and Daniel Kahneman in their paper Judgment under Uncertainty: Heuristics and Biases. In a simple experiment they asked participants to quickly guess the product of an equation. Some participants had to guess the value of the equation: 1 x 2 x 3 x 4 x 5 x 6 x 7 x 8. Other participants were asked to guess the value of the equation: 8 x 7 x 6 x 5 x 4 x 3 x 2 x 1. The median guess for the ascending equation was 512 where the median guess for the descending equation was much higher at 2,250 (Tversky & Kahneman, 1974). The ordering of the equation prompts the mind to expect the value of an equation that starts with a larger number is larger than an equation that starts with a smaller number. They also found that offering payoffs for accuracy did not seem to diminish the anchoring effect (1974). Another paper by Wegener et al. finds that anchoring is not just numerical but also effects

8 attitudes and judgments (2010). These effects on decision-making are similar to other findings by Kahneman et al. (1986b) that survey respondents found certain actions by firms acceptable or unfair based on other information in a given example. This indicates that people value and assess information in context with the other information around it. 6.Design and Methods This experiment uses a simple between-subject design and a single round in each session. A game with multiple rounds gives responders the incentive to reject offers so that proposers will increase the offer in subsequent rounds. In this scenario rejections can be used as strategic behavior to coerce proposers to offer larger shares to responders to prevent losing their own share. By removing the strategic element of rejections the outcomes should be more indicative of the natural behavior of participants in a bargaining situation. Proposers choices in a baseline treatment were limited between two options: they either propose a split of five extra credit points for themselves and one extra credit point for the responder, or they propose an equal split of three extra credit points for both themselves and the responder. This treatments results are a calibration by which the results of the experimental treatment are compared to. Proposers in the experimental treatment could either propose a split of five extra credit points for themselves and one for the proposer, or one extra credit point for themselves and five extra credit points for the responder. Each experiment was conducted with participants from economics classes at the Langdale College of Business Administration. Envelopes with a form were randomly passed out to half of the students. These students take the role of proposer. The rules of the game were explained and the proposers opened their envelopes. Upon completing the proposer portion of the forms, they were placed back into envelopes, collected, and then redistributed to students who did not receive envelopes the first time. Those students filled out the responder portion of the form and placed them back into the envelopes that were then collected. The experiment was performed in four sessions. Two sessions received the baseline treatment and two sessions received the experimental treatment. Sessions one and three, containing a combined 31 pairs, received the first treatment. Sessions two and four, containing a combined 33 pairs, received treatment two. The goal of the design is to identify if empathetic behavior in the experimental group will reduce the rejection rate of low 5,1 offers. The hypothesis is that the rejection rate of low offers in the experimental group is less than the rejection rate of low offers in the control group: HR: (Rejection Rate Of Low Offers) Experimental < (Rejection Rate Of Low Offers) Baseline This will be tested against the null hypothesis that the treatment has no effect on the rejection rate of low offers. This experiments main focus is the behavior of responders to 5,1 offers. However, the results will also include a look at the treatments effect on proposer behavior and what it might suggest. Also there is restriction in the way data in economic experiments can be collected. Economists have largely deemed the use of deception in experimental methods taboo with the idea being that if the participants suspect deception they will not only alter their behavior for a given experiment, thus making it a null representation of the treatments effects, but will also alter their behavior in future experiments by other researchers. It would be tempting to place all participants in the role of the responders, administer prefilled forms with low offers, and tell

9 participants that other students made the offers. However, the possibility that students suspect the pretense would render the results void. Students had to respond to real offers from real students. Because of this, the sample size of low offers presented to responders could only be determined after the experiment was completed. 7.Results The graphical representations of the experiments results can be seen in figure 3 below.
Figure 3. (a) The amount of low offers made by proposers as a percentage of total offers. (b) The rejection rate of low offers.

Low Offers From Proposers


100.00% 80.00% 60.00% 40.00% 20.00% 0.00% Treatment 1 Treatment 2 19.35% 84.85%

Rejection Rate of Low Offers


80.00% 60.00% 40.00% 20.00% 0.00% Treatment 1 Treatment 2 66.67% 35.71%

(a)

(b)

There were 31 total offers in treatment one. Six proposers in treatment one made low offers (n=6). Of those six offers, four were rejected. The baseline rejection rate of low offers is 66.67 percent. There were 33 total offers made in treatment two. Proposers in treatment two made 28 low offers (n=28). Ten of the low offers in treatment two were rejected. The rejection rate for low offers in treatment two is approximately 35.71 percent. Using a Fishers exact test to calculate the p value shows that the experimental treatment has a significant effect on the behavior of proposers (p < 0.0001). Proposers in treatment two make low offers much more than proposers in treatment one. The exact nature of these effects can not be determined with out designing additional treatments. It may be that proposers in the experimental treatment value fairness but when faced with diametrically unfair options choose the one with higher payoffs for themselves. It could also be the case that proposers expect the responders to view their behavior as justifiable given their circumstances and make the low offer because they believe they will not be punished for it. The data suggests that the treatment effect on rejection rates is a decrease of 31%. P values calculated using both a Fishers exact test and regression analysis confirm that the effect is not statistically significant (p = 0.173; p = 0.172). Table 1 shows the OLS estimation results.

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Table 1 Variable Treatment Effect Adj-R2 F-Stat N

Coefficient Estimate -0.31 0.028 1.952 34

T-Value

P-Value

Significance Level -

-1.397

0.172

Ultimately the results of this experiment do not support the hypothesis presented. Therefore I cannot conclude that the treatment has any effect on a responders willingness to accept low offers. There are a few possible explanations for this. The first is that the treatment actually does not affect responders willingness to accept low offers. It is also possible that the sample size of low offers in treatment one was too small to get an accurate baseline. This is not too surprising. Most of the literature suggests that proposers are likely to pick the fair option. Another possibility is that saliency of extra credit points is greater than dollars. This would mean that responders are less likely to reject extra credit points than dollars. I hope that in the future I may be able to perform the experiment again with some additional treatments and larger samples. 8.Conclusion My suspicion before beginning research was that people with incomplete information make use of contextual clues to fill in gaps in their information. In the context of this experiment I expected that the responder, who does not know with certainty the intentions of the proposer, would see that the proposer offered a 5,1 split. The responder then compares that to a 1,5 split and concludes that the proposers hands were tied. From there they would project this sense of empathy unto the proposers intentions and assume that the proposer is not selfish. Identifying this behavior would have implications in any bargaining situation but especially so in wage negotiation theories from labor economics. Another interesting application could be in the way psychologists diagnose Aspergers syndrome. Aspergers syndrome (AS) is similar in nature to autism but much less profound. People with an AS diagnosis are usually unable to perform the sort of extrapolation that socially normal people could in the experimental treatment. Currently the process of diagnosing of AS does not do well in discerning between people who are extremely antisocial and people who are incapable of behaving socially normal ways. Although the results presented in this paper show no significant effect I am not confident in the data. I would like to collect a larger sample before drawing any definitive conclusions. Future sessions could yield a larger number of low offers if the proposer is de-biased before participating. Informing the proposer, and only the proposer, of the expected Nash equilibrium could do this. There are some additional treatments that could also yield some interesting information on this topic. A simple one is a treatment in which the responder knows the offer made by the proposer but not what the alternate offer is. Comparing it to the experimental treatment from this paper could reinforce the hypothesis that the comparison of the low to a restricted alternative offer is what prompts the responder to exhibit empathy.

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References
Empathy [Def. 2]. (n.d.). In Merriam Webster Online, Retrieved March 9, 2013, from http://www.merriam-webster.com/dictionary/empathy. Falk, A., & Fischbacher, U. (2006). A theory of reciprocity. Games and Economic Behavior, 54(2), 293315. Fehr, E., & Schmidt, K. M. (1999). A theory of fairness, competition, and cooperation. The quarterly journal of economics, 114(3), 817-868. Gth, W., Schmittberger, R., Schwarze, B. An experimental analysis of ultimatum bargaining, Journal of Economic Behavior & Organization, Volume 3, Issue 4, December 1982, Pages 367-38 Hoffman, E., Mccabe, K., Smith, V. (2008a). Reciprocity In Ultimatum And Dictator Games: An Introduction. In C.Plott & V. Smith (Eds.) Handbook of Experimental Economic Results. (Pp. 411-416). New York: North-Holland Hoffman, E., Mccabe, K., Smith, V. (2008b). Preferences And Property Rights In Ultimatum And Dictator Games. In C.Plott & V. Smith (Eds.) Handbook of Experimental Economic Results. (Pp. 411-416). New York: North-Holland Kahneman, D., Knetsch, J. L., & Thaler, R. H. (1986). Fairness and the Assumptions of Economics. Journal Of Business, 59(4), S285-S300. Kahneman, D., Knetsch, J. L., & Thaler, R. (1986). Fairness as a Constraint on Profit Seeking: Entitlements in the Market. American Economic Review, 76(4), 728. Tricomi, E., Rangel, A., Camerer, C., & O'Doherty, J. (2010). Neural evidence for inequality-averse social preferences. Nature, 463(7284), 1089-1091. doi:10.1038/nature08785 Tversky, A., & Kahneman, D. (1974). Judgment under Uncertainty: Heuristics and Biases. Science, (4157), 1124. doi:10.2307/1738360 Wegener, D. T., Petty, R. E., Blankenship, K. L., & Detweiler-Bedell, B. (2010). Elaboration and numerical anchoring: Implications of attitude theories for consumer judgment and decision making. Journal of Consumer Psychology, 20(1), 5-16. Young, L., & Saxe, R. (2009). Innocent intentions: A correlation between forgiveness for accidental harm and neural activity. Neuropsychologia, 47(10), 2065-2072.

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Appendix: Procedural Materials [Baseline Bargaining Form] This Section Is For Proposers Only.

Proposer ID number: __________________________________


Check only one of the following boxes. [ ] 5 extra credit points for the proposer, 1 extra credit point for the responder. 3 extra credit points for the proposer, 3 extra credit points for the responder.

[ ]

This Section Is For Responders Only.

Responder ID number: __________________________________


Check only one of the following boxes. [ ] I accept, and extra credit points will be determined by the proposal above. I reject, and we will both receive no extra credit points.

[ ]

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[Treatment Bargaining Form] This Section Is For Proposers Only.

Proposer ID number: __________________________________


Check only one of the following boxes. [ ] 5 extra credit points for the proposer, 1 extra credit point for the responder. 1 extra credit points for the proposer, 5 extra credit points for the responder.

[ ]

This Section Is For Responders Only.

Responder ID number: __________________________________


Check only one of the following boxes. [ ] I accept, and extra credit points will be determined by the proposal above. I reject, and we will both receive no extra credit points.

[ ]

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