Language, Deception, and Social Loss in an Investment/Trust Game

Abstract

Accounting scandals entail both self-serving actions and manipulated reporting and disclosure by managers. The social and private losses from such events are thus an issue of major importance. We report results from a modified investment/trust game experiment where deception and information manipulation emerge endogenously in the context of interaction between two parties with competing interests. Our evidence shows that communication between the parties enables social contracts to coordinate joint behavior, but these contracts are frequently breached when hard evidence on outcomes cannot be supplied. Cheaters also adopt sophisticated strategies when breaching that involve concealing the breach through ambiguous actions, reducing the private gains they extract, and manipulating information available to their trading partners. While economies with communication exhibit frequent cheating on contracts, these economies generate total social losses that are slightly lower than and statistically indistinguishable from similar economies where behavior is made transparent through evidence provision. Cheating does have consequences for the distribution of wealth, but these private losses are modest since cheaters must sustain a minimum level of trust for their trading partners to continue interaction. The main implication of our evidence is that communication between self-interested parties is a powerful force in achieving gains from interaction in part because cheaters balance personal gains from deception and information manipulation against the need to sustain the trust that generates ongoing benefits from economic interaction.

Keywords: Breach of contract, deception, disclosure information manipulation, trust game

JEL Classification: M4, C91, D82