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Cognition and Decision-Making: Laws, Norms and Contracts

Final Report Summary - COGNITION (Cognition and Decision-Making: Laws, Norms and Contracts)

1. Cognition and identity. A major achievement of this first axis of research was to develop the first cognition-based model of identity. In Identity, Morals and Taboos: Beliefs as Asset, published in the QJE, Roland Bénabou and the PI developed a theory of moral behavior, individual and collective, based on a general model of identity in which people care about “who they are”. This research sheds light on many empirical puzzles inconsistent with earlier approaches such as taboos, escalating commitments, the potential dysfunctionality of competing identities, and finally the ostracizing of do-gooders. Individual and Corporate Social Responsibility (Economica), studied society’s demands for individual and corporate social responsibility, in terms of the adoption of a longer-term perspective by firms, the delegated exercise of prosocial behavior on behalf of stakeholders, and insider-initiated corporate philanthropy. Laws and Norms studies questions hitherto ignored by economists such as norms-based interventions, namely campaigns and messages that seek to alter people’s perceptions of what constitutes normal behavior or values among their peers, and expressive role of law, which, beyond imposing material incentives, sends a message about society’s values. The paper has been the impetus for important empirical work by other researchers.

2. Cognition and liquidity in financial markets. One of the key objectives of this ERC project was to understand how the ability to privately acquire information affects markets. An investigation along this line is “Information, Tranching and Liquidity” with Emmanuel Farhi (JET). The PI wrote a paper on “Cognitive Games and Cognitive Traps”, investigating the structure of games in which the players pick an information structure for themselves or other players prior to playing an arbitrary normal or extensive form game, and another paper “Cognition-Intensive Contracting” with a more specific focus on contracts.

3. Public intervention in the presence of limited information. Public policy is often hampered by a lack of knowledge of the authorities vis-à-vis those whose incentives they design. This informational gap in turn has substantial implications for institutions. The project covered by the grant has investigated these issues in a variety of settings. In Market Power Screens Willingness-to-pay, published in the QJE, Glen Weyl and the PI investigate optimal rewards to innovation. The State would like to encourage innovations but lacks information about their cost, their quality and the size of their potential market. In Overcoming Adverse Selection: How Public Intervention Can Restore Market Functioning, published in AER, the PI considers a market that, for informational reasons, has dried up and provides a first analysis of market jumpstarting. In Collective Moral Hazard, Maturity Mismatch, and Systemic Bailouts, published in AER, Emmanuel Farhi and the PI show that support to distressed institutions that is imperfectly targeted due to informational reasons provides a rationale for macroprudential policies. In Bubbly Liquidity, published in REStud, Emmanuel Farhi and the PI analyze the possibility and the consequences of rational bubbles in a dynamic economy where financially constrained firms demand and supply liquidity. “Country Solidarity in Sovereign Crises", published in AER, asks, when will solidarity, which emerges spontaneously from the fear of spillovers, be reinforced through contracting? Emmanuel Farhi and the PI developed a game theoretic modeling of the two-way interaction between re-nationalization of financial markets and sovereign fragility, highlighting the incentives of the various players in creating a dangerous situation ("Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops”, mimeo).

4. Miscellaneous. The PI has also worked in environmental economics (“From Pigou to Extended Liability: on the Optimal Taxation of Externalities under Imperfect Financial Markets”, REStud, “Regional Initiatives and the Cost of Delaying Binding Climate Change Agreements”, with Julien Beccherle JPubE, "Negotiating Effective Institutions against Climate Change", with Christian Gollier, EEEP); managerial compensation ("Bonus Culture: Competitive Pay, Screening and Multitasking", with Roland Bénabou JPE); industrial regulation with work on standard setting and patent pools (with Josh Lerner: "A Better Route to Tech Standards," Science; “Standard Essential Patents", JPE; with Patrick Rey: "Cooperation vs. Collusion: How Essentiality Shapes Co-opetition"); on the economics of payment cards industry ("Must-Take Cards: Merchant Discounts and Avoided Costs," with Jean-Charles Rochet JEEA, "Shrouded Transaction Costs”, with Hélène Bourguignon and Renato Gomes).
The PI published 20 articles, 10 of them in top-5 economics journals and 1 in Science, over the period covered by the grant, as well as 2 books. Some of the work has impacted guidelines of competition authorities regarding a) payment cards and b) patent pools, and has influenced debates on climate change and on banking and European institutions.