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Are CEOs expected utility maximizers?

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  • List, John A.
  • Mason, Charles F.

Abstract

Are individuals expected utility maximizers? This question represents much more than academic curiosity. In a normative sense, at stake are the fundamental underpinnings of the bulk of the last half-century's models of choice under uncertainty. From a positive perspective, the ubiquitous use of benefit-cost analysis across government agencies renders the expected utility maximization paradigm literally the only game in town. In this study, we advance the literature by exploring CEO's preferences over small probability, high loss lotteries. Using undergraduate students as our experimental control group, we find that both our CEO and student subject pools exhibit frequent and large departures from expected utility theory. In addition, as the extreme payoffs become more likely CEOs exhibit greater aversion to risk. Our results suggest that use of the expected utility paradigm in decision making substantially underestimates society's willingness to pay to reduce risk in small probability, high loss events.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 162 (2011)
Issue (Month): 1 (May)
Pages: 114-123

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Handle: RePEc:eee:econom:v:162:y:2011:i:1:p:114-123

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Web page: http://www.elsevier.com/locate/jeconom

Related research

Keywords: Decision making under uncertainty High stakes Experiments;

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References

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  1. repec:fth:coluec:645 is not listed on IDEAS
  2. Chichilnisky, G. & Heal, G., 1993. "Global Environmental Risks," Discussion Papers 1993_03, Columbia University, Department of Economics.
  3. Chew, S H & Epstein, Larry G & Segal, U, 1991. "Mixture Symmetry and Quadratic Utility," Econometrica, Econometric Society, vol. 59(1), pages 139-63, January.
  4. Kenneth E. Train, 1998. "Recreation Demand Models with Taste Differences over People," Land Economics, University of Wisconsin Press, vol. 74(2), pages 230-239.
  5. John List, 2006. "Field experiments: A bridge between lab and naturally occurring data," Artefactual Field Experiments 00083, The Field Experiments Website.
  6. Ernst Fehr & John A. List, 2004. "THE HIDDEN COSTS AND RETURNS OF INCENTIVES — TRUST AND TRUSTWORTHINESS AMONG CEOs," Labor and Demography 0409012, EconWPA.
  7. John List & David Reiley, 2008. "Field experiments," Artefactual Field Experiments 00091, The Field Experiments Website.
  8. Hey, John D & Orme, Chris, 1994. "Investigating Generalizations of Expected Utility Theory Using Experimental Data," Econometrica, Econometric Society, vol. 62(6), pages 1291-1326, November.
  9. Harless, David W., 1992. "Predictions about indifference curves inside the unit triangle : A test of variants of expected utility theory," Journal of Economic Behavior & Organization, Elsevier, vol. 18(3), pages 391-414, August.
  10. John List & Charles Mason, 2009. "Are CEOs Expected Utility Maximizers?," NBER Working Papers 15453, National Bureau of Economic Research, Inc.
  11. David Revelt & Kenneth Train, 1998. "Mixed Logit With Repeated Choices: Households' Choices Of Appliance Efficiency Level," The Review of Economics and Statistics, MIT Press, vol. 80(4), pages 647-657, November.
  12. Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
  13. Haigh, Michael S. & List, John A., 2002. "Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis," Working Papers 28554, University of Maryland, Department of Agricultural and Resource Economics.
  14. Hey, John D., 1995. "Experimental investigations of errors in decision making under risk," European Economic Review, Elsevier, vol. 39(3-4), pages 633-640, April.
  15. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
  16. Machina, Mark J, 1987. "Choice under Uncertainty: Problems Solved and Unsolved," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 121-54, Summer.
  17. Daniel McFadden & Kenneth Train, 2000. "Mixed MNL models for discrete response," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 15(5), pages 447-470.
  18. Charles Mason & Jason Shogren & Chad Settle & John List, 2005. "Investigating Risky Choices Over Losses Using Experimental Data," Journal of Risk and Uncertainty, Springer, vol. 31(2), pages 187-215, September.
  19. Evans, Dorla A, 1997. "The Role of Markets in Reducing Expected Utility Violations," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 622-36, June.
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Citations

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Cited by:
  1. Lefebvre, Mathieu & Vieider, Ferdinand M., 2011. "Risk Taking of Executives under Different Incentive Contracts: Experimental Evidence," Discussion Papers in Economics 12210, University of Munich, Department of Economics.
  2. Luca Corazzini & Stefano Galavotti & Rupert Sausgruber & Paola Valbonesi, 2012. "Allotment In First-Price Auctions: An Experimental Investigation," "Marco Fanno" Working Papers 0153, Dipartimento di Scienze Economiche "Marco Fanno".
  3. John List, 2013. "Using field experiments to change the template of how we teach economics," Artefactual Field Experiments 00389, The Field Experiments Website.
  4. Jeffery Flory & Uri Gneezy & Kenneth Leonard & John List, 2012. "Sex, competitiveness, and investment in offspring: On the origin of preferences," Artefactual Field Experiments 00072, The Field Experiments Website.
  5. List, John A. & Mason, Charles F., 2011. "Are CEOs expected utility maximizers?," Journal of Econometrics, Elsevier, vol. 162(1), pages 114-123, May.

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