Faculty of Economics and Business Administration Publications Database

Institution Formation in Public Goods Games

Okada, Akira
Riedl, Arno
Volume: 99
Number: 4
Pages: 1335 - 1355
Month: September
ISSN-Print: 0002-8282
Link External Source: Online Version
Year: 2009
Keywords: Public goods; Institutions; Sanctions; Cooperation

Sanctioning institutions are of utmost importance for overcoming free-riding tendencies and enforcing outcomes that maximize group welfare in social dilemma situations. We investigate, theoretically and experimentally, the endogenous formation of institutions in public goods provision. Our theoretical analysis shows that players may form sanctioning institutions in equilibrium, including those governing only a subset of players. The experiment confirms that institutions are formed and that it positively affects cooperation and group welfare. However, the data also shows that success is not guaranteed. Players are unwilling to implement equilibrium institutions in which some players have the opportunity to free ride. Our results emphasize the role of fairness in the institution formation process.