Abstract
When people anticipate financial support, they may reduce preventive effort. We conjecture that the source of financial support can mitigate this moral hazard effect due to social preferences. We compare effort choices when another individual voluntarily provides financial support against effort choices under purely monetary incentives. When financial support is provided voluntarily by another individual, we expect recipients to exert more effort to avoid bad outcomes (level effect) and to reduce effort provision to a lesser degree as financial support becomes more generous (sensitivity effect). We conducted an incentivized laboratory experiment and find some evidence for the level effect and strong evidence for the sensitivity effect. This leads to significant gains in material efficiency with expected wealth being 5.5% higher and 37.3% less volatile.
Highlights
Financial support is commonly observed for a variety of risks such as natural disasters, economic dislocation, sickness and injury
According to [4], the provision of government relief is inefficient in situations where individuals can engage in self-protection because it reduces effort incentives. [5] reviews the history of natural disaster grant and loan programs in the US and argues that protecting citizens from the full consequences of their risky decisions leads to inefficiency and makes financial support self-perpetuating
We conducted a laboratory experiment to analyze how effort provision is affected by financial support
Summary
Financial support is commonly observed for a variety of risks such as natural disasters, economic dislocation, sickness and injury. Private forms of financial support are mostly evident after major world events, for example $2.4 billion in donations made to the victims of 9/11, $1.6 billion raised by US charities for disaster relief after the 2004 tsunami and $3.3 billion in cash raised after Hurricane Katrina [1]. In terms of experimental research, [7] find moral hazard in a public goods context
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