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«An agent advises a principal on selecting one of multiple projects or an outside option. The agent is privately informed about the projects’ ...»

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Pandering to Persuade

By Yeon-Koo Che and Wouter Dessein and Navin Kartik∗

An agent advises a principal on selecting one of multiple projects

or an outside option. The agent is privately informed about the

projects’ benefits and shares the principal’s preferences except for

not internalizing her value from the outside option. We show

that for moderate outside option values, strategic communication

is characterized by pandering: the agent biases his recommenda-

tion toward “conditionally better-looking” projects, even when both parties would be better off with some other project. A project that has lower expected value can be conditionally better-looking. We develop comparative statics and implications of pandering. Pan- dering is also induced by an optimal mechanism without transfers.

A central problem in organizations and markets is that of a decision-maker (DM) who must rely upon advice from a better-informed agent. Starting with Crawford and Sobel (1982), a large literature studies the credibility of “cheap talk” when there are conflicts of interest between the two parties. This paper addresses a novel issue: how do differences in observable or verifiable character- istics of the available alternatives affect cheap talk about non-verifiable private information? In a nutshell, our main insight is that the agent’s desire to persuade the DM ineluctably leads to recommendations that systematically pander toward alternatives that look better. We study how pandering affects strategic commu- nication and its implications for market and organizational responses, including optimal mechanism design.

In any number of applications, a DM has partial “hard” or verifiable informa- tion about the options she must choose between. For instance, a corporate board deciding which capital investment project to fund has some prior experience about which kinds of projects are more or less likely to succeed; a firm that could hire a consultant to revamp its management processes knows which procedures are being implemented at other firms; or buyers can read product reviews. Yet, the ∗ Che: Department of Economics, Columbia University, and YERI, Yonsei University, 420 W. 118th St., New York, NY 10027 (e-mail: yc2271@columbia.edu); Dessein: Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall, New York, NY 10027 (e-mail: wd2179@columbia.edu);

Kartik: Department of Economics, Columbia University, 420 W. 118th St., New York, NY 10027 (e-mail:

nkartik@columbia.edu). We thank Vince Crawford, Ian Jewitt, Justin Johnson, Emir Kamenica, Vijay Krishna, Jonathan Levin, Stephen Morris, Ken Shotts, Joel Sobel, Steve Tadelis, Tymon Tatur, a num- ber of seminar and conference audiences, and anonymous referees and the Co-editor (Larry Samuelson) for helpful comments. Youngwoo Koh, Petra Persson, and Sebastien Turban provided excellent research assistance and Kelly Rader helped with proofreading. Portions of this research were carried out at the Study Center at Gerzensee (ESSET 2010) and Yonsei University (part of the WCU program); we are grateful for their hospitality. We also appreciate financial support from the Korea Research Foundation (World Class University Grant, R32-2008-000-10056-0), the National Science Foundation (Grant SES-0965577), and the Alfred P. Sloan Foundation.

1

2 THE AMERICAN ECONOMIC REVIEW MONTH YEAR

agent — the CEO, consultant, or seller respectively — has additional “soft” or unverifiable private information about the options. Crucially, the available hard information can affect the DM’s interpretation of the agent’s claims about his soft information. The reason is that any hard information typically creates an asymmetry among the options from the DM’s point of view. Our interest is in understanding how such asymmetry influences the agent’s strategic communication of his soft information.

The incentive issues arise in our model because of a conflict of interest about an outside option, or status quo, that is available to the DM in addition to the set of alternatives that the agent is better-informed about. For instance, the outside option for a corporate board is to not fund any capital investment project, or for a buyer it could be to not purchase any product from the seller (or purchase from a different seller). The outside option is typically more desirable to the DM than the agent. In our baseline model, this is the only conflict of interest. More precisely, any alternative to the outside option has some value that is common to both the DM and the agent, but these values are each drawn from some distribution (which may be different for each alternative) and are private information of the agent.

On the other hand, the agent derives no benefit from the outside option, whereas the DM gains some commonly-known benefit from choosing it. Equivalently, the DM bears a resource cost of implementing any of the alternatives to the outside option, but this cost is not internalized by the agent.

In this setting, the strategic problem facing the agent is to persuade the DM that some alternative is better than the outside option while at the same time inducing the DM to choose the (mutually) best alternative. This captures an essential feature of many applications, including each of the examples mentioned above.





Cheap-talk communication here takes the form of comparisons, i.e. in equilibrium, the agent’s message can be interpreted as a recommendation about which alternative provides higher value and hence should be chosen by the DM.1 Our central insight is that any observable differences between the alternatives — formalized as non-identical distributions of values — will often force the agent to systematically distort his true preference ranking over the alternatives. We show that the agent will sometimes recommend an alternative that is “conditionally better-looking” (in a sense explained below) even though he knows that it is in fact worse than some other alternative. This happens despite the fact that both the agent and the DM would be better off if the latter alternative were instead chosen. In other words, the agent systematically panders toward certain alternatives on the basis of publicly observable information. Although aware of the pandering distortion, the DM always accepts the agent’s recommendation of the conditionally best-looking alternative in any influential equilibrium, while she is more circumspect when the agent recommends conditionally worse-looking alter

–  –  –

natives, in the sense that she sometimes chooses the outside option when such alternatives are recommended.

Despite the common interest the two parties have over the set of alternatives, the pandering distortion in communication is unavoidable when the conflict of interest over the outside option is not trivial. If the agent were to always recommend the best alternative, then a recommendation for certain alternatives would generate a more favorable assessment from the DM about the benefit of foregoing the outside option. Consequently, for moderate outside option values, the DM would accept the agent’s recommendation of these alternatives but stick with the outside option when some other alternatives are recommended. This generates the incentive for the agent to distort recommendations. The incentive to distort becomes more severe when the value of the outside option to the DM is higher.

Building on this basic observation, we show how influential communication can take place in spite of the agent’s incentive to pander, so long as the outside option is not too large. The logic is that if the agent recommends an alternative that would not be acceptable to the DM under a truthful ranking only when it is sufficiently better — not just better — than the others, it becomes more acceptable to the DM when recommended. Why would the agent distort his recommendation in this way? The incentive is generated by the DM’s asymmetric treatment of recommendations: she accepts some recommendations with probability one but others with probability less than one. It is worth stressing that, for moderate outside options, it is precisely the fact that the agent panders in equilibrium which makes all of his recommendations persuasive; without pandering, some recommendations would never be accepted. In other words, endogenous discrimination by the agent against an alternative can benefit the alternative by making it credible to the DM when it is recommended.

After an illustrative example in Section I, we develop a general model in Section II. Section III identifies a key stochastic ordering condition for the distributions from which the value of each alternative is drawn. We show that when the ordering condition holds, the direction of pandering is systematic in any influential equilibrium of the cheap-talk game once the outside option is sufficiently high for the DM, i.e. when the agent truly needs to persuade the DM to forego the outside option. We also show that the degree of pandering rises with the outside option, up until a point where influential communication is no longer possible.

The stochastic ordering of alternatives can be intuitive in some cases, such as when it coincides with ex-ante expected values. But the opposite can sometimes be true: an alternative that has lower ex-ante expected value (and is even dominated according to first-order stochastic dominance or even in likelihood ratio) can nevertheless be the one that the agent panders toward. This highlights the economics of strategic communication in the present context: what matters is not the evaluation of alternatives in isolation, but rather in a comparative ranking, i.e. when an alternative is recommended over all others. In particular, what drives the direction of pandering is the ranking of the DM’s posterior expectation

4 THE AMERICAN ECONOMIC REVIEW MONTH YEAR

about each alternative when the agent truthfully reveals that the alternative is better than all others. For this reason, we refer to alternatives being conditionally better- or worse-looking than others, and pandering is toward the conditionally better-looking alternatives.

Section III also explores various implications of the characterization of pandering. Of note is that the DM’s ex-ante welfare can decrease when his outside option increases, and that conditionally worse-looking alternatives become more credible or acceptable to the DM when the slate of alternatives is stronger (formally, when the distribution of any alternative improves in the sense of likelihood-ratio dominance).

Section IV examines to what extent the DM can mitigate the cheap-talk distortion when she has commitment power. We study optimal mechanisms without transfers. We find that, under a mild regularity condition, if pandering arises in the cheap-talk game then even an optimal mechanism induces pandering, but to a lesser degree than under cheap talk. This implies that the pandering phenomenon identified in this paper is not driven by the DM’s inability to commit, but rather by the asymmetry between the projects and the conflict of interest over the outside option. Furthermore, we show that the optimal mechanism can be implemented within a class of simple mechanisms, in particular by delegating decision-making to an appropriately-chosen intermediary who must then play the cheap-talk game with the agent. We also find that full delegation to the agent (Aghion and Tirole, 1997; Dessein, 2002) dominates pure communication with the DM whenever the latter involves pandering.

Although the model we focus on is stylized, it is straightforward to extend in a number of ways to suit different applications. The conclusion, Section V, briefly mentions a few of these directions, such as adding conflicts of interest even among the alternatives to the outside option. A number of appendices available online provide supplementary material.

This paper connects to multiple strands of literature. The logic of pandering is related to Brandenburger and Polak (1996).2 They elegantly show how a manager who cares about his firm’s short-run stock price will distort his investment decision towards an investment that the market believes is ex-ante more likely to succeed. However, their model is not one of strategic communication, but rather has an agent making decisions himself when concerned about external perceptions. As a result, we study a different set of issues, including various forms of commitment and other responses by the DM, and we shed light on a broader set of applications. Our analysis and findings are also more refined because of a richer framework.3 For example, as already mentioned, in our setting the agent 2 See also Blanes i Vidal and Moller (2007). Heidhues and Lagerlof (2003) and Loertscher (2010) study similar themes in the context of electoral competition.

3 Their model has two states, two noisy signals, and two possible decisions. We have continuous and multi-dimensional state space, perfectly informative signals, and an arbitrary finite number of decisions.

Moreover, the preferences for the agent in our model are more complex because he also cares about the benefit of the chosen alternative and not just about whether the outside option is foregone.

VOL. VOL NO. ISSUE PANDERING TO PERSUADE 5

may pander toward an alternative with lower ex-ante expected value, which does not arise in Brandenburger and Polak (1996).



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