Risking Other People's Money: Experimental Evidence on the Role of Incentives and Personality Traits

• Date: 01 April 2020
• Published date: 01 April 2020
• DOI: http://doi.org/10.1111/sjoe.12353

Scand. J. of Economics 122(2), 648–674, 2020

DOI: 10.1111/sjoe.12353

Risking Other People’s Money:

Experimental Evidence on the Role of

Incentives and Personality Traits*

Ola Andersson†

Uppsala University,SE-751 20 Uppsala, Sweden

ola.andersson@nek.uu.se

H˚akan J. Holm

Lund University,SE-220 07 Lund, Sweden

hj.holm@nek.lu.se

Jean-Robert Tyran‡

University of Vienna, A-1090 Vienna,Austria

jean-robert.tyran@univie.ac.at

Erik Wengstr ¨om

Lund University,SE-220 07 Lund, Sweden

erik.wengstrom@nek.lu.se

Abstract

Decision-makers often face incentives to increase risk-taking on behalf of others (e.g., they are

offeredbonus contracts and contracts based on relative performance). Weconduct an experimental

study of risk-taking on behalf of others using a large heterogeneous sample, and we find that

people respond to such incentives without much apparent concern for stakeholders. Responses

are heterogeneous and mitigated by personality traits.The findings suggest that a lack of concern

for others’ risk exposure hardly requires “financial psychopaths” in order to flourish, but it is

diminished by social concerns.

Keywords: Competition;hedging; incentives; risk-taking; social preferences

JEL classification:C72; C90; D30; D81

*We thank Ulrik H. Nielsen for effective research assistance and the Carlsberg Foundation for

generous financial support. The Swedish authors thank the Swedish CompetitionAuthority for

funding. Earlier versions of the paper have been presented at the 5th and 6th Nordic Conferences

on Behavioral and Experimental Economics in Helsinki (2010) and Lund (2011), respectively,

the CNEE Workshop in Copenhagen, and the University of Innsbruck, University of Oslo, the

Research Institute of Industrial Economics, and the Royal Institute ofTechnology in Stockholm.

We are grateful for comments bysession par ticipants on these occasions.

†Also affiliated with the Research Institute of Industrial Economics, Stockholm.

‡Also affiliated with the Universityof Copenhagen, Denmark.

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The editors of The Scandinavian Journal of Economics 2019.

O. Andersson et al. 649

I. Introduction

Risk-taking on behalf of others is common in many economic and financial

decisions. Examples include fund managers investing their clients’ money

and executives acting on behalf of shareholders. To motivate decision-

makers, the authority to take decisions on behalf of others is often coupled

with powerful incentives. A basic problem with this practice is that it is

typically hard to construct compensation schemes that perfectly align the

incentives of decision-makers with the interests of stakeholders. Indeed,

in the wake of the financial crisis of 2007–2009, actors in the financial

sector have been routinely accused of taking increased risk on behalf of

investors.

The introduction of advanced financial products has expanded

opportunities to hedge risks, creating further incentives for increased risk-

taking. During a public hearing in the US Senate involving the CEO of

a leading investment bank, it emerged from internal e-mails that the bank

had taken bets against its own clients’ investments to hedge their profits.1

Moreover, Andrew Haldane, Chief Economist and Executive Director at

the Bank of England, argues that the problems in the banking sector are

rooted in the fact that the private risks of financial decision-makers are not

aligned with social risks, and that the latter are of a much greater magnitude

(Haldane, 2011). In addition, Rajan (2006) suggests that new developments

in the finance industry – such as added layers of financial management and

new complex financial products – have exacerbated the problem.

The arguments made in the previous paragraph suggest that increased

risk-taking is undesirable from a societal point of view. However,

theoretically, one can argue that increased risk-taking is desirable. It is

well known in the finance literature that incentive schemes can be used

to increase risk-taking beyond what is motivated by the decision-makers’

risk preferences (Shavell, 1979). The argument usually made is that the

owners of capital are well diversified and thereby interested in maximizing

dividends payout (risk neutrality). However, the decision-makers are not

well diversified and, if risk averse, they might take suboptimal decisions

if the reimbursement scheme does not compensate for the difference in

risk exposure and risk preferences. Such compensation might come from

incentive schemes that induce a positive risk shift (e.g., by introducing

competition or bonus schemes, as in this paper). An alternative motivation

is that owners of capital are risk averse, and aware of it, but would like their

1See the article, “Revealed: Goldman Sachs ‘made fortune betting against clients’” by Terry

Macalister in The Observer, 25 April 2010 (https://www.theguardian.com/world/2010/apr/25/

goldman-sachs-senator- carl-levin).

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The editors of The Scandinavian Journal of Economics 2019.