Money is great for buying stuff, but a new study by University of Iowa finance professors suggests it's also useful for keeping score and might help people make better decisions.
"If you offer incentives to people, it generates more economically rational decisions," says Thomas Rietz, professor of finance in the Tippie College of Business. "The incentive doesn't even have to be money. If it's just a way to keep score, it still makes a difference."
Without any kind of incentive, he said peoples' decisions may seem irrational and have little logical connection.
Rietz and his co-authors—Joyce Berg, professor of accounting at UI, and the late John W. Dickhaut, professor of economics and accounting at Chapman University—reached their award-winning conclusions by modifying an experiment that economists and psychologists have used for decades to determine peoples' motivations. In the experiment, a subject is shown two circles drawn on paper. Both circles are divided into two regions, and each region has a payoff. One of the circles is considered high risk because it has a small region with a high payoff and a large region with a low payoff—say, $36 and $4.
The other circle is considered low risk because its two payoffs are of relatively equal value—say, $14 and $15.
The subject is then asked which circle she would choose if she were given a spinner, spun it on either circle, and received the money on which the spinner landed. The answer is recorded, and the examiner moves on to another pair of similarly divided circles, and then another, and so on.
The subjects are also asked which of the circles they valued more by assigning each circle a dollar amount.
In the past, researchers noted that the subjects' responses were often logically inconsistent because they would frequently choose to spin on a circle that they valued less. This was interpreted to mean that the subjects were making irrational decisions, casting doubt on the bedrock economic theory that people make decisions after logically evaluating their choices and picking the option that's most valuable.
But Rietz and his co-researchers wondered, what would happen if you actually allowed the subjects to spin the spinner on one of the circles instead of asking a purely hypothetical question? If you let the subjects play out the chosen gamble, would that change their choices?
They found that it did. By giving the subjects a spinner and letting them spin on their chosen circle, choices became more consistent. This was true, Rietz says, whether the subjects actually received the money or not, indicating that the subjects made more rational decisions even when the outcome was nothing more than a way to keep score.
"Just seeing how many points you win makes a huge difference," says Rietz. By keeping the experiment hypothetical, subjects often stated inconsistent preferences. But let them spin, and while they still made random mistakes, they revealed stable underlying preferences.
Rietz says this suggests that people will make more rational decisions if they're given an incentive, even if the incentive is only something minor.
"Even incentives that are not economically valuable still motivate people. Employee of the month programs don't offer anything more valuable than a special parking spot or a photo on the wall, but that's enough to motivate a lot of employees to be better workers."
"Even incentives that are not economically valuable still motivate people," he says. "Employee of the month programs don't offer anything more valuable than a special parking spot or a photo on the wall, but that's enough to motivate a lot of employees to be better workers."
Rietz noted that online video game companies use these kinds of motivations to keep customers. In many of these games, such as World of Warcraft or Call of Duty, gamers receive points for completing certain tasks, like collecting spells or blowing enemies' heads off. Eventually, though, gamers who play long enough would eventually collect the maximum points, then lose interest and quit.
"When you've reached the top, there's no incentive to accumulate more points and so you stop playing," he says.
But this is bad for the video game company because then the gamer also lets his monthly subscription lapse. So to keep these gamers interested and paying to play the game, some companies started allowing those who reached the pinnacle to cash in all their points and start over, and in return gave them an emblem of some kind to indicate that they'd achieved the game's ultimate success. Every time they max out and start over, they get another emblem. Even though the reward has no value except maybe to boost the player's legend in the gaming world, it's enough of an incentive for them to keep playing the game.
This isn't to say that people don't make mistakes, Rietz says. They make mistakes all the time, but bad doesn't mean they are systematically irrational.
Rietz's and Berg's paper -- "The Play Out Effect and Preference Reversals: Evidence for Noisy Maximization" -- won the best paper award last month at "Experimental Economics, Accounting and Society: A Conference in Memory of John Dickhaut" at Chapman University.