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Are CEOs Expected Utility Maximizers?

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  • John List
  • Charles Mason

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

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15453.

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Date of creation: Oct 2009
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Handle: RePEc:nbr:nberwo:15453

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References

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  1. Chew, S H & Epstein, Larry G & Segal, U, 1991. "Mixture Symmetry and Quadratic Utility," Econometrica, Econometric Society, vol. 59(1), pages 139-63, January.
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  6. Michael Haigh & John List, 2005. "Do professional traders exhibit myopic loss aversion? An experimental analysis," Artefactual Field Experiments 00052, The Field Experiments Website.
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  10. John List, 2006. "Field experiments: A bridge between lab and naturally occurring data," Artefactual Field Experiments 00083, The Field Experiments Website.
  11. Kenneth E. Train, 1998. "Recreation Demand Models with Taste Differences over People," Land Economics, University of Wisconsin Press, vol. 74(2), pages 230-239.
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  13. Hirshleifer,Jack & Riley,John G., 1992. "The Analytics of Uncertainty and Information," Cambridge Books, Cambridge University Press, number 9780521283694.
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  15. 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.
  16. 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.
  17. 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.
  18. 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.
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  20. 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.
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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.

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