CeDEx Seminar - Matthew Embrey (University of Sussex)

Gambling in Risk-Taking Contests: Experimental Evidence

Abstract: In this paper, we experimentally test whether contest schemes induce excessive risk-taking behavior by implementing the contest model by Seel and Strack (2013). In their stylized setting, managers who face contest payoffs have an incentive to delay halting projects with negative drift. Furthermore, Seel and Strack (2013) demonstrate that the induced inefficiency is quasi-convex in the drift, i.e., highest for a moderately negative expectation. The experimental design systematically varies the negative drift (between-subjects) across three values—minimally negative, moderately negative and extremely negative. In all cases, subjects are predicted to engage in some gambling. In addition to the contest structure, we also implement a lottery version where subjects no longer have an incentive to gamble. We find that subjects gamble for all levels of the drift during the contest, as predicted by the theory. Furthermore, we find support for the quasi-convexity predicted by the the- ory. However, we also find significant levels gambling in the lottery setting, something not predicted by the theory. We provide further evidence on the strategies subjects choose and the patterns of learning that they display, and discuss the extent to which the results can be explained by either a “joy of gambling” hypothesis or by a theory of regret.