An Experimental Investigation of Moral Hazard in Costly Investments

Frequently, parties make sequential decisions regarding investments for which the probability of success or failure is dependent upon the amount of total investment. This paper reports a series of experiments involving a costly investment game which is derived from the catalytic finance model of Morris and Shin (2006). The sequential nature of investments is such that the second investment could function as a complement to the initial investment or simply serve as a substitute to it thereby creating moral hazard. The features of this game are similar to those of the ultimatum game. However, there are several key differences between the games which may account for the high frequency of materially self-interested behavior that we observe, particularly among second movers