Outcome Bias and Delegated Decision Making - Theory and Experiment

In a theory-guided experiment, I study how outcome bias, a tendency of principals to reward
and punish economic agents as if they could have anticipated a random state of the world, shapes
the incentives and choices of agents. Agents choose between two lotteries on behalf of their princi-
pal. One lottery is first-order stochastically dominant, but the dominated lottery is more likely to
yield a higher payoff state-by-state. Despite perfectly observing the agent’s choice, principals tend
to reward agents if they choose the lottery, which realizes a higher payoff. As a result, they incen-
tivize agents to choose the dominated lottery. Although most agents anticipate these incentives,
only strategically sophisticated agents tend to choose the dominated lottery when they believe
they have an incentive to do so. Structural estimation suggests that most principals are either
fully outcome-biased or fully unbiased, with less cognitively sophisticated principals displaying
more outcome bias. These findings suggest that outcome bias is most relevant in settings where
sophisticated agents meet relatively unsophisticated principals.