Here’s my column from the WSJ this week — and if you have any questions for me, just email them to askariely@wsj.com

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Dear Dan,

In your answer last week about splitting checks at restaurants, you noted that there is a “diminishing sensitivity as the amount of money paid increases.” I’ve noticed this in my own spending. I’ll go out of my way to save a buck and then spend an ungodly sum on some purse. Why is that? And how can I control it?

—Lembry

Diminishing sensitivity is a very basic way that our minds work across many domains of life. For example, imagine that you light up one candle in the middle of the night. This small amount of light will dramatically change your ability to see your surroundings. But what if you already have 10 lit candles and you add one more? Now it would not have much of an effect. The basic idea of diminished sensitivity is that our minds tend to register relative increase; we take any additional amount of stuff as if it were a percentage gain, not an absolute one.

Now, when it comes to money, we should think about it in absolute terms ($10 is $10 regardless of whether we are saving it from a dinner bill or from the price of a new car), but we don’t. We think about money in terms of percentages, too.

What can we do about it? It’s not easy, but we should try to fight this natural tendency. One method that I use from time to time is to take the amount of money that I am thinking about spending and ask myself what else I could get with it. For example, since I like going to the movies (and let’s say that the price of two tickets and popcorn is $25), I ask myself whether a given $25 of spending on a prospective purchase is worth more or less than the pleasure of going to the movies.

When framed this way, it doesn’t matter if the savings come from a dinner bill or a new computer—and it helps me to ask the question “What would I enjoy more?” in a more concrete way. So, the next time you are shopping for a new purse, try to measure its price in terms of another use for that money that you might value more.

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Dear Dan,

I have been on vacation for the last few days in New York City, and while reading your most recent book, on dishonesty, I have been wondering whether people behave more or less honestly on vacation.

—Julie

This is an interesting question, and (sadly) I don’t have any data to share with you on this topic. But here are a few ideas to consider:

Why might people on vacation be more honest? While on vacation people seem to be more relaxed with spending money, which suggests that the motivation to be dishonest for financial gain might be lower. On top of that, people on vacation are more often in a good mood, which they might not want to spoil by behaving badly.

Why might people on vacation be less honest? On vacation, the actions we take are in a new context. As they say, “What happens in Vegas stays in Vegas.” Also, the rules on vacation might seem less clear: What are the regulations for parking in San Francisco? How much should you tip in Portugal? Is it OK to take the towels from this hotel? This sort of wishful blindness can make it easier for us to misbehave while still thinking of ourselves as generally wonderful, honest people.

On balance, then, are vacationers more or less honest? I suspect that they are less honest—but I would love to be proven wrong.

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Dear Dan,

What is it about Internet communication—Facebook, Twitter, email—that seems to make people descend to the lowest common denominator?

—James

It’s easy to blame the Internet, but I think we see such behavior mostly because people generally gravitate toward trafficking in trivialities. Consider your own daily interactions. How much is witty repartee—and how much is the verbal equivalent of cat pictures? The Internet just makes it easier to see how boring our ordinary interactions are.

See the original article right here.

Here’s my column from the WSJ this week — and if you have any questions for me, just email them to askariely@wsj.com

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Dear Dan,

What should I do about parking? I have trouble deciding whether I should go for a paid parking lot straight away or drive around in the hope of finding free parking—but at the risk of wasting time.

—Cheri

This is a question about the value of your time. You need to figure out how much money an hour of fun out of the house is worth to you and compare that cost with the time it takes to find a parking spot. For example, if an hour out of the house is worth $25 to you, and searching for parking takes 30 minutes on average, then any amount less than $12.50 that the parking lot charges you is worth it. As the number of people in your car rises, the value of parking quickly also rises because the waste of time and reduction of value accumulate across all the people in your group.

Another computational approach is to compare the misery you feel from paying for parking with the misery you feel while seeking a spot. If the misery from payment isn’t as great as the unhappiness from your wasted time, you should go for the parking lot. But if you do this, you shouldn’t ignore the potential misery you would feel if you paid for parking and then found a free spot just outside your destination. Personally, the thought of time wasted is so unbearable to me that I usually opt for paid parking.

Yet another approach is to put all the money that you intend to spend on going out in an envelope in advance. As you’re on the way to the restaurant or movie theater, decide whether that money would be better spent on parking or other goods. Is it worth it to forgo that extra-large popcorn if paying for parking will get you to the theater on time? That makes the comparison clearer between what you get (quick parking and more time out) and what you give up.

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Dear Dan,

When going to dinner with friends, what is the best way to split the bill?

—William

There are basically three ways to split the bill. The first is for everyone to pay for what they’ve had, which in my experience ends the meal on a particularly low point. Every person has to become an accountant. Given the importance of endings in how we frame our memories of experiences, this is a particularly bad approach. Rather than remembering how delicious the crème brûlée was, you may be more likely to remember that Suzie ate most of it even though you paid for half.

The second approach is to share the bill equally, which works well when people eat (more or less) the same amount.

The third approach, my favorite, is to have one person pay for everyone and to alternate the designated payer with each meal. If you go out to eat with a group relatively regularly, it winds up being a much better solution. Why? (A) Getting a free meal is a special feeling. (B) The person paying for everyone does not suffer as much as his or her friends would if they paid individually. And (C) the person buying may even benefit from the joy of giving.

Let’s take the example of two friends, Jaden and Luca, who are going out to their favorite Middle Eastern restaurant. If they were to divide the cost of the meal evenly, each would feel, say, 10 units of misery. But if Jaden pays, Luca would have zero units of misery and the joy of a free meal. Because of diminishing sensitivity as the amount of money paid increases, Jaden would suffer fewer than 20 units of misery—maybe 15 units. On top of that, he might even get a boost in happiness from getting to buy his dear friend a meal.

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Dear Dan,

I play in a weekly nine-hole golf league. There’s one individual who constantly talks on his cellphone, moves around while others are putting and mostly ignores the courtesies of golf. He’s been asked to stop this behavior but continues with a bully attitude. How do I handle it?

—Wally K.

Though you might be tempted to rip the phone from his hands, throw it on the ground and bash it with your 9-iron, I would suggest another solution.

You could implement a new rule, whereby everyone else playing with you earns a mulligan (a “do over” shot) each time the bully talks on the phone. Getting constant negative feedback (in addition to giving everyone a performance boost) would probably whip him into shape. Just be sure to take the mulligans consistently, every time he’s on the phone, so that his behavior is reliably punished and the message sticks.

See the original article here.

There was a time when farmer’s markets, eco products, recycling, and renewable energy were squarely in the tree hugger’s domain. Then, somewhere along the line, green went mainstream, turning environmental awareness into a socially desirable trait and a mark of morality.

 

But is eco-friendliness always a boon? When University of Toronto researchers Nina Mazar and Chen-Bo Zhong recently looked into this, they found that under certain circumstances, green products can license us to act immorally.

 

Through a series of experiments, Mazar and Zhong drew the following distinction between two kinds of exposure to green: When it’s a matter of pure priming (i.e., we are reminded of eco products through words or images), our norms of social responsibility are activated and we become more likely to act ethically afterwards. But if we take the next step and actually purchase the green product (thereby aligning our actions with our moral self-image), we give ourselves the go-ahead to then slack off a little and engage in subsequent dishonest behavior.

 

So in effect, a green purchase licenses us to say “I’ve done my good deed for the day, and now I can think about my own self-interest.” I gave $20 to a charity, I pledged support to NPR, I did my share — that sort of thing. How moral we choose to be at any given moment depends not only on our stable character traits but also on our recent behavior.

 

This implies that if you have two important environmental decisions to make on a given day, your early decision may impact the later one. If you choose a mug over a paper cup for your morning coffee, you may later decide it’s okay not to recycle if a bin isn’t handy. This choice could even affect your subsequent moral choices in other areas, since the moral licensing effect is not domain-specific. (Participants in the above-mentioned experiment, for example, were more likely to cheat and steal cash after making green purchases).

 

All this to say that we need to think carefully about the unintended consequences of all the decisions we make. While we may consider the consequences of questionable decisions (speeding or parking illegally for example), we rarely consider the effects of “good” ones.

 

My 2-year cell phone contract was up last month, and even before the date when I could opt for an upgrade, I began to experience the pain of indecision: which was it going to be – a Samsung Galaxy S3 or an iPhone 5? I was one of the only Android (HTC Evo) users in our Center for Advanced Hindsight team, and swayed by the rest of the group’s dedication to Apple, I was looking forward to switching to the new iPhone as soon as my contract was up. But I was not going to be able to befriend the newest iOS 6-adorned Siri until the iPhone’s release in a couple of months. In today’s impatient tech age, that is an eternity. My longing for an Apple clashed with my itching desire to get a new phone.

After watching a hopeless number of face-off videos, reading about the features and specs of Galaxy S3 compared with the endless mock ups of the rumored iPhone 5, and even throwing the question around at dinner parties, I decided to come to my senses, listen to what research has to say, and make an irrationally rational decision. Though surely evidence from decades of research is not limited to the following considerations, I picked a number of conceptual tools from decision-making research that could help shed light on this quandary of iPhone vs. Samsung:

1. Now vs. Later: I should pit my short-term interest in having a new smartphone now against my long-term interest in having an iPhone later. Temporal discounting suggests that we have the tendency to want things now rather than later, and delaying gratification depends on whether we are convinced that what will happen in the future is going to be better than what we can have now. In other words: howmuch better is this nebulous iPhone of the future when I could have this immediately awesome Galaxy S3?  Given that the specs of Galaxy S3 are available but those of the iPhone 5 are not, it might be smart to bet for what is certain. (Winner: Galaxy S3)
2. Misremembering the past vs. mispredicting the future: I can go with the certain specs of Galaxy S3, or potentially recall my past experiences with iPhones and decide accordingly. Sadly we are bad at remembering past feelings; rather than correctly weighing the positives and negatives we remember the peak moments and selected experiences. Since I am unable to accurately recall my past emotional states, then maybe I can imagine how much pleasure each of these phones could bring me in the future? Unfortunately, we are also notoriously bad at predicting the duration and intensity of future feelings. (Winner: Galaxy S3)
3. Want vs. need: Do I want a new phone? Yes. Do I really need a new phone? No, because my old one is still in good shape. With the irresistible discounts of signing up for a new 2-year plan, I am conditioned by the cell phone market to switch to a new phone as soon as possible. This conditioning moves me from casually wanting a new device to absolutely needing it to survive (!). I feel that the longer I wait, the more I am giving up on a perceived opportunity. (Winner: wait until my current phone gives up, and then get an iPhone 5).
4. Decoy options iPhone 4s vs. HTC Evo: In my indecision, I can introduce a third option that is asymmetrically dominated either by Galaxy S3 or iPhone 5. If I consider iPhone 4S as a potential option, it would (hopefully) be dominated by iPhone 5 but could still be superior to the Galaxy S3 with the ease of its use, compactness and such. If I am leaning more towards the Android options, then I can consider staying with HTC Evo as a potential third choice, and given that Galaxy S3 surpasses my old Android in nearly every domain, I would lean towards upgrading to Samsung. (Winner: Depends on the decoy option)
5. Reactance to unavailability: The brands also complicate the issue as they control supply and increase demand by playing with the availability of their products as well as the timing of their release. This can create several types of responses:

• Since iPhone 5 is currently unavailable, I experience a pressure to select iPhone 4S which is a similar alternative. If I perceive this as a limitation on my freedom to choose, I might react by selecting a dissimilar option. (Winner: Galaxy S3)
• The unavailability of iPhone 5 could also lead me to perceive it as more desirable. (Winner: iPhone 5)
• Or I can just despise what I can’t have. (Winner of the sour grapes story: Galaxy S3)

So, what should I do? Given the considerations above, there is still no clear winner for me. Yes, I have the plague of newism: I run after the genuine, exciting proposition of the emerging trends and products. Yes, I know there is something good now, but possibly something better around the corner.

At the end of the day, I will toss a coin: not because it will settle the question for me, but because in that brief moment when the coin is in the air, I will suddenly know which side I hope to see when it lands in my palm. And besides, whether I purchase my new phone from Apple or from Samsung, I will stick to my commitment, almost immediately forget about the forsaken option, and justify my choice infallibly in retrospect.

~Lalin Anik~

This week, I visited a camera store to order two enlarged prints as a gift.  I don’t order photo prints very often; in fact, I’m not sure that I have ever ordered prints aside from graduation photos.  As I was making my purchase, the friendly, middle-aged woman who had been helping me asked whether I wanted to become a store “member.”  I learned that for only 13 dollars and change, I could save 10% on purchases at the store for the next year, including around five dollars on the order I was purchasing.  (I asked whether this discount applied to cameras.  It did not.)  After fleeting consideration, I explained that I did not think it was likely that I would be buying more prints in the next year, and hence membership was not a worthwhile purchase for me.

To the friendly saleswoman, this did not seem be a satisfactory answer.  She continued to push the membership offer, emphasizing the five dollars that I would be saving.  “I don’t know about you,” she said, “but I’m someone who likes saving money.”

As I walked from the camera store to my car, I couldn’t help but contemplate this saleswoman’s comment.  Did she actually believe that purchasing a camera store membership would benefit my bank account in the long run (as she appeared to), or was she simply a loyal store representative, eager to make additional sales (which seemed more likely)?  Either way, her comment reflected a “save by spending” mentality that permeates modern-day America.

Membership programs and customer reward programs that charge an initial fee are prime examples of the “save by spending” creed.  The customer is presented with various opportunities for future discounts, provided he or she coughs up money for a membership.  As in my camera store situation, the membership offer is usually presented right before purchase, and the amount saved on the purchase itself is highlighted by the salesperson.  The customer is forced to decide on the spot whether he or she would like to join.

Membership programs are rather curious in light of the established research finding that, in general, people will settle for less money if they can have it immediately – a tendency psychologists refer to as temporal discounting.  (Think Money Mart loans or pawnshops.)  In contrast, joining a membership program means foregoing money now for the possibility of earning that money back later on.

There are several reasons these programs may work.  First, they force the consumer to project the likelihood of future purchases in a biased setting.  People are notoriously bad at predicting the future; when buying an enticing summer novel at Barnes and Noble, surrounded by other books, one is more likely to consider spending money on books than on the variety of other products out there.  Second, when presented with the membership program, people may experience mild social pressure from the sales associate.  Third, if people are making their purchases with credit cards, they’ll be more willing to slap on an additional membership purchase; research attests that using credit cards makes people spend more, compared with cash.

Last but not least, the feeling of saving money is just plain rewarding.  We know that money is valuable.  At the same time, we don’t want to save by foregoing that sparkly new iPhone accessory.  Membership programs offer us the opportunity to have our cake and eat it too – to experience the joys of saving and spending at the same time.  And I’m guessing this makes companies pretty happy too.

Of course, membership programs aren’t the only example of our tendency toward saving by spending.  Who hasn’t relished in the experience of buying a product at 50% off, focusing on that 50% that they have magically “earned”?  I know I have.  This may be part of the reason that the average American has half as much personal savings as personal debt.

Thank you, kindly saleswoman, but I will simply pay for my photo prints this time.

~Heather Mann~

I just received this letter from a friend in the banking industry. He prefers to remain anonymous (you’ll see why soon enough).

Dear Mark,

There’s been a lot of ballyhoo recently about your IPO and your choice of investment bankers. Indeed, a war was fought by the banks to win your “deal of the decade.”  As reported in the press, the competition was so intense banks slashed their fees in order to win your business. Facebook is “only” paying a 1% “commission” for its IPO rather than the 3% typically charged by the banks.

Congratulations, Mr. Zuckerberg! On the surface it appears your pals in investment banking have given you a quite a deal!… Or have they?

Let’s take a closer look and see what you’re getting for your money.

To start, your bankers have the task of selling 388 million Facebook shares to the public. In return, these banks will receive $150 million for their efforts.  Morgan Stanley will get the largest share of that amount—approximately $45 million. But is $45 million all that Morgan Stanley makes off your deal?

Before we answer this question, let’s first dissect the sales pitch that Morgan Stanley probably gave you to justify “only” the $150 million fee. We’ll look at what they told you, and then what that actually means.

1) We will raise the optimal amount of money for the company, for our 1% fee. (Translation: How great is it that Zuckerberg believes he got a great deal by getting us down to a 1% fee! We can’t believe he got hoodwinked into agreeing to any level of what are actually variable commission fees.)

2) The definition of a successful deal is having a good price “pop” on the first day of trading. This will make all parties happy and you, Mark, look like a rock star. (Translation: No one benefits more than us if Facebook’s share price rises significantly on day one. That first day price “pop” will take money directly out of your pocket and puts it in ours and those of our “best friends”—not yours or the public stockholders. We will, at almost all costs, make this happen.)

3) This is a very complicated process, especially for such a large company, but we are here to successfully guide you through it. (Translation: It actually takes the same amount of work to do a large IPO as a small one. Thus for approximately the same amount of work we’re doing for Facebook, we sometimes get only $10 million—$140 million less than we’re making on Zuckerberg’s IPO.)

4) We will perform due diligence on your company to make sure the business and its finances are as they seem. (Translation: While it certainly does take some time and effort to perform reasonable due diligence, Facebook is a very large and well-known company, and we have done this same procedure hundreds of times.)

5) We will write a prospectus that outlines Facebook’s strategy, business plan, financials, and risks, and we will get it approved by the SEC. (Translation: Per the regulatory guidelines, a prospectus is largely a boilerplate document; for the most part, it’s just a lot of cutting and pasting.)

6) Once this prospectus is completed and with input from the Facebook team, we will come up with “the range” or the approximate price we think your IPO shares should be sold at to the fund managers. (Translation: The price of your IPO will be determined by where and how we can best optimize our (secret) profits on the deal.)

7) We believe the best shareholders are large fund managers, as they will become long-term holders of Facebook stock.  However, at your request, we will allocate 25% of the IPO shares to sell to individual investors. (Translation: There are 835 million Facebook users worldwide. One could argue that what is best for Facebook would be to let all of Facebook’s legally eligible customers enter orders to buy Facebook stock. Then through the broker of their choosing, they could enter the quantity of shares they want to buy and the price they want to pay, just like the fund managers do—or are supposed to do. More on this scenario below.)

8) Our 10-day sales process will begin. For this important “road show,” you will be introduced to our large fund manager clients. These fund managers will receive our pitch for why they should buy your stock, and we will assess their interest and at what price. (Translation: Far from being long-term holders, many of our large fund manager “best friends” will, as soon as Facebook shares start trading, sell (or “flip”) for a windfall profit on all the underpriced shares we’ve given them. We’ll enable this by creating a perceived “feeding frenzy” for the stock by putting out an artificially low initial estimate ($28 to $35 per share) for where we think the IPO will be priced.  We will then raise that estimate during the road show. Rumors about this begin to circulate over the next day or so.)

9) At the end of the road show on the night before the IPO, we will review the overall supply and demand for the stock and then “price” the shares. This is the price at which the large fund managers will receive their “winning” Facebook shares. (Translation: The price of the stock is already known. For the past few years, Facebook shares have been actively trading on such venues as SecondMarket and SharePost.)

10) And finally, we will put a mechanism, called a Greenshoe, in place that “supports” your share price after the IPO. (Translation: Thank God Zuckerberg doesn’t understand one of the greatest investment banking profit enhancing creations of all time—“The Greenshoe.” The Greenshoe will likely be our most profitable part of this deal.  It’s a secret windfall, and although we market it to Facebook as a method to stabilize its share price, it’s really just another way for us, with little effort, to make huge amounts of money.)

We’re not done yet, Mark. Now, I’d like to dig a bit deeper into what’s going to happen and show you all the additional ways your banker friends and their large fund manager clients are going to make oodles of money off your deal.

1) Morgan Stanley only gives Facebook shares (“golden tickets”) to their best client “friends.”  In other words, it’s no coincidence that Morgan Stanley’s biggest fund manager clients get the bulk of the shares offered in this kind of deal.

2) How do you become best friends with Morgan Stanley?  There are lots of ways, such as trading tens of millions of shares with them or using the firm as your prime broker.

3) I’m sure there are a lot of conversations going on right now between Morgan Stanley’s salespeople and their clients. These conversations are probably along the lines of (wink-wink) “before we allocate our Facebook shares, we’d like to ask first if you plan to do more trading with us over the next week to six months….”

4) Let’s assume that 50 of Morgan Stanley’s “best friends” trade an extra 2 million shares so they can get access to more shares of the Facebook IPO. Let’s also assume that the average commission these clients pay to Morgan Stanley is 2 cents per share. Well, those extra trades will dump an additional $2 million dollars into Morgan’s coffers.

5) Now comes the part where Morgan Stanley actually gives free money to its friends. If the Facebook IPO is like the majority of other recent Internet offerings, here’s what Morgan Stanley will likely do.  They know Facebook will be a “hot” deal. Especially, with all of the “5% orders” coming in, there will be huge demand for Facebook shares.  My prediction is that Morgan Stanley will “price” Facebook at approximately $40 per share.  This is the price at which Morgan Stanley’s “best friends will be able to buy the bulk of the 388 million shares offered.

6) Now let’s now assume that Facebook shares open for trading at $50—a lower percentage premium than Groupon’s opening share-price “pop.”

7) Let’s assume that one of Morgan Stanley’s “best friends” decides to sell 3 million shares right after the opening at $50 per share. That “best friend” will instantaneously make a $30 million profit.  That’s right, a $30 million profit.

8) Here’s a question for you Mark. If Morgan Stanley’s “best friends” are selling Facebook shares at $50, who’s buying them? The answer is your “friends,” individual investors, most of whom are your customers.

9) Now for the final insult—the Greenshoe. Technically speaking, the Greenshoe gives your investment banks a 30-day option to purchase up to 15% more stock from Facebook than was registered and sold in the IPO. In layman’s terms, this means that, over the next 30 days, your “best friends” at the investment banks are able to buy approximately 50 million of your shares at $40 per share.

10) As in our example above, let’s say Facebook shares do trade at $50 soon after the IPO. Now I am a simple person, but if I were given the opportunity to buy something at $40 that I could immediately sell at $50, I would do it all day, every day…. And so will the investment banks.  The Greenshoe actually gives these banks the ability to do this for 50 million of your shares.

11) So let’s assume that Morgan Stanley and its other banking “friends” buy 50 million shares at $40 per share and then sell these shares at $50.  Morgan Stanley and its banking “friends” will make an additional $500 million- yes, $500 million- a HALF BILLION DOLLARS off your company.

So let’s now do a tally to see how much money all of your banking friends are going to make just for the privilege of doing your IPO.  Let’s also see where this money comes from.

“Discounted” fees/commission: $150 million

Greenshoe profits: about $500 million

Extra trading commissions from large fund managers: approximately $10 million

—————

Investment Bank Profits:   $660 million

As the lead bank on your deal, Morgan Stanley is likely to get 30% of the overall take. This means that your closest investment banking “friend” will make a bit more than $200 million from your IPO.

Morgan Stanley and the rest of the investment banks involved will also make sure that their favorite fund manager client “friends” are given lots of free money. Assuming that these “friends” are given 75% of the total number of IPO shares, or a total of 291 million shares, and assuming that the stock does rise from $40 to $50, then these fund managers will collectively, in one day, make $2.9 billion dollars in realized or unrealized profits.  That’s right, 2.9 BILLION DOLLARS.

Mark, by now you must be asking yourself the obvious question. “Where and out of whose pocket does this money come from?”

Well, just think of it this way… Let’s assume you own a very expensive piece of waterfront real estate, and you hire a broker to sell it for you. After exploring the market and after getting indications of interest, your broker advises you that $10 million would be a great price for your home.  You meet with the potential buyers and decide to sell it for $10 million.  After the $1 million commission you have to pay your broker, your net proceeds are $9 million. An hour later, you drive by the house and see your broker in the driveway shaking hands with some different people. You pull over to see what’s going on, and you find that the people you just sold the house to for $10 million are very close friends of your broker.  To your dismay, you also find out that those friends just sold your (former) house to somebody else for $15 million.

The same exact game is going on here, Mark. You’ll be selling 388 million shares of Facebook stock in your IPO. A likely scenario is that your broker “friends” are telling you to sell your shares at $40 per share. You’ll take their advice and sell at $40 per share, and the buyers will be Morgan Stanley’s biggest fund management clients. By the time you drive around the block, these folks will have sold their shares at $50 per share. In other words, using the same real estate scenario, you’ll have sold something of yours for $15 billion that is really worth $19 billion. And for that “unique” privilege, you’ll be paying your “friends” at the banks $150 million as a fee.

Makes you wonder who your real friends are…

————-

End of letter

————-

I find the points that my (real life) friend makes here highly disturbing, but I suspect that they also fit with what we now know about dishonesty.

First, although there are many ethically questionable practices occurring here, it’s not clear that anything illegal is going on.  Second, I think that while this banking industry’s IPO process is artfully designed in such a way that, although overall it’s good for the bankers and less so for the companies, no single individual believes he/she is doing anything wrong.  Third, I also suspect that since this is such a common practice, the bankers most likely truly believe that mechanisms such as getting a first-day IPO “pop” is great for Facebook and that the Greenshoe is fact put in place to stabilize the Facebook stock price, and not simply to generate more windfall profits for themselves.  Forth, they probably believe in their own definition of a “successful” IPO, which in their terms is one where the stock is priced at $40 and quickly trades up to $50. In the case of Facebook, this process simply redistributes $4 billion from Facebook to the banks and the large fund managers. For Zuckerberg and his team, I have to wonder whether the emotional value of a first day share price “pop” is worth $4 billion.

I am not sure about you, but I find all of this very depressing.

Irrationally yours,

Dan

We’ve known for a while that both the processes and products of the pharmaceutical industry need to be regulated. The roots of this regulation stretch back over a century, but it’s been since the Kefauver-Harris Drug Amendments were passed in 1962 in response to thousands of severe birth defects caused by the drug thalidomide that drug manufacturers were for the first time required to prove the effectiveness and safety of their products to the FDA before marketing them. Since that time, we’ve created huge obstacles in terms of time, money, and evidentiary rigor between drug manufactures and the market; on average, it takes about 10-15 years and hundreds of millions of dollars for a drug to make it from the lab to the pharmacy. And as we come to a greater understanding about conflicts of interest and prescribing patterns, we also regulate the activities of pharmaceutical companies at even smaller level, such as when and to whom they can give pens or free lunches.

In stark contrast, we have the financial industry. In this domain, no one needs to prove the safety or effectiveness of financial products such as derivatives and mortgage-backed securities. This is because we make two major assumptions about such products based on economic theory: we presume first that they have  sound internal logic and second, that the market will correct problems and mistakes if something goes awry with one of these new inventions.

In theory we could make the same argument for pharmaceutical products as well. Medications are also developed based on logic—in this case chemical and biological—and a group of experts assume that they will be effective based on this logic. We can also assume that the market would weed out bad medications, just as it weeds out unsuccessful companies and products. How would it do this? Well, people who take bad medications would become ill or die, other people would find out, and over time this process would preserve the demand for medications that work well—the same logic that is applied to financial products. Despite these parallels, there’s an incredible lack of symmetry in how we view regulating these markets.

People remain highly suspicious of one market (pharmaceutical), and far less so of the other (financial), but when we compare the systems in broad strokes, their similarities are evident. A paper I read recently got me thinking more about this comparison. In both cases, the industries in question get more money if people use more of their products, and both use salespeople to convey information about their products to consumers. So far that’s pretty standard fare in business. Less common is the similarity that these salespeople have incentives such that they benefit from selling the product, but lose nothing when it fails. Moreover, in both cases the product is complex and difficult to understand, even at the expert level. Additionally, there is substantial asymmetry in the knowledge of salespeople versus that of consumers. And in both cases, the stakes are very high, with physiological health and financial health in question. And while death rarely occurs as a direct result of financial products, the damage they can do is immense (see the financial crisis of 2008).

Yet we apprehend the dangers inherent in a free pharmaceutical market while remaining generally oblivious to those in the financial. No one protests along libertarian lines of letting pharma be free, or shouts from a podium that if the government just stayed out of our treatments and medications, amazing and innovative new cures would suddenly appear. Why then don’t we see the need to regulate the financial market?

I believe that one of the reasons for this discrepancy is that the casualties and damage done in the pharmaceutical domain are far more apparent. When things go badly in medicine, it’s easier for us to quantify them and make clear causal connections. Whereas in the financial market it’s generally the case that lots of people lose some money, but people rarely lose everything. Moreover, in the financial market, there are never just losers, there are always winners as well—someone will gain a lot from a losing transaction, and that’s frequently chalked up to how the system works. With pharmaceutical losses, the injury or death of patients far exceeds any gain the company might make (and then lose in litigation). Also, with medications, the counterfactual is generally much stronger. There are people who took a drug and those who didn’t, and often a clear comparison of the difference emerges. In economics it’s far more difficult to make a causal connection, after all, there is still debate over whether the first and second bailouts helped anyone other than the institutions that got paid directly.

Given the similarities between the markets, and the differences in how we tend to regard them, I think we need an FDA-like entity and process for financial products, because if we don’t have a counterfactual, we can’t compare and measure the value of their products. We could call it the FPA, for Financial Product Administration. One example of a financial tool that the FPA could test is high frequency trading. Companies are going all out to profit by being the fastest to buy and sell stocks, owning them for fractions of a second; they even go so far as to buy buildings closer to the stock market to make trading faster. The logic behind high frequency trading is that companies can take advantage of even tiny price fluctuations. And it’s possible that in principle they’re adding to the efficiency of the market, but it’s more likely that they increase volatility, and frighten people off the market, and therefore have a negative effect. It’s an understatement to say that this strategy is focused on the short term, whereas investment ideally is about a longer-term commitment. But regardless of one’s beliefs on whether high frequency trading is ethically sound, it would be nice to know for sure if it makes the markets better or worse off before allowing it.

 

By the way, one thing I appreciated most about the paper that inspired this post is that the authors are from the University of Chicago—home of the free market champions. That’s a departmental seminar I wouldn’t mind sitting in on.

When I first moved to the U.S. for graduate school (which was a long time ago), I was very intrigued by and excited about the tax system and tax day. I envisioned it as a matter of civic engagement, a yearly ritual where citizens reflected on their contribution to the common pool of resources—for better and for worse. I imagined that people would consider the benefits of taxes—being able to fund schools, build roads and bridges, care for the poorest members of the community, and fund the defense of the U.S.—while at the same time watching for wastefulness and protesting against it.  And indeed this is how I looked at tax day for my first few years here.

Fast forward to when I finished graduate school and started making a real income, then I began to see April 15^th the way most other people do. I realized that the tax code is so complex and aggravating that instead of making people consider values and social issues, their contribution to society, and government waste, it is mostly a season of shared grumbling and annoyance trying to get all your records together in time. With all of this complexity and ambiguity (is taking your sister for dinner while she’s in town and discussing work projects a legitimate business expense?  What if she gives you a good idea that you later use?), the only bonding we have on tax day is over the tedium of figuring out how much we owe and over the continual worry of whether we have done things correctly or not. So instead of promoting civic mindedness, the way the U.S. tax system is structured now highlights the small details of filing taxes. As a result, all of our attention is directed toward ending the irritating procedure, and in the process trying to find as many loopholes in the tax code as possible in order to minimize how much we pay.

So how can we fix this problem?  The first step is to simplify and clarify the tax code to make the process less confusing. The process of figuring and filling out tax forms is so exasperating it’s hard not to direct that feeling toward someone or something—and generally speaking, that something is the agency that seems responsible for your suffering, which in this case is the IRS. After all, it’s difficult to maintain a cheerfully civic-minded outlook, or even an even-keeled neutral outlook, in the face of such frustration.

Now imagine the simplest, least irritating approach to taxation. The least bothersome way of paying taxes is to have it done for you; for instance, in Israel, the government takes taxes out of people’s income before they even receive their salary. This means that in Israel, no one really knows their gross pay, but they do know their net pay, which makes them much more realistic about what they make. Generally speaking, the opposite is true in the U.S., where people know their gross but not net pay.

This is one idea, and it certainly would simplify things, but it would also nullify the idea of tax day as a day of citizenship and a time of reflection. So while we want to minimize the procedural pain of tax day, we don’t necessarily want to eliminate the possibility of thoughtful and critical participation in government that it provides. To make it a more beneficial experience, I think citizens should be asked how they want the government to spend their tax money. I don’t mean in the larger sense of voting for a political candidate and his or her economic ideology, nor do I mean the total amount that an individual pays in taxes; rather, I think there should be a section on tax forms that prompts the taxpayer to decide how to allocate 10% of his or her taxes. The choices could be among education, clean energy, health care, defense, roads and infrastructure, and so on. Not only would this give taxpayers a more apparent role in deciding where their money goes, it would avoid the problem of missing the forest for the trees.

With a less frustrating and more participatory tax system, it’s possible we could remake tax day into a more constructive and less arduous occasion. And maybe (maybe) we could get the government to be more responsible.

For now though, we should all look around at what our taxes pay for—the roads, the streetlamps, the police and fire stations—and remember that paying taxes is just part of life.

Happy tax day!

Will Rogers once said that “The income tax has made liars out of more Americans than golf” and I worry that he was correct. During his confirmation hearing to become the Treasury Secretary, it was revealed that Tim Geithner failed to pay Medicare, Social Security, and payroll taxes for several years while he worked for the International Monetary Fund (IMF). When asked by Senator John Kyl (R AZ) during the hearing about the (more than $40,000) “mistake,” which Geithner blamed on the tax software he was using, he replied, “it was very clear that this was an avoidable mistake… You’re right. I had many opportunities to see it.” But he didn’t, apparently, and that was that.

There are many problems here—one of which is the possibility of a double standard that allowed Geithner to get away with this entirely (I am not sure if this is the case or not). I suspect that if he had he been working for a domestic monetary agency, that is, the IRS, he would have faced heavy prosecution, fines, and almost certainly been fired.  Also, as the future head of the Treasury, we might hope that he understands the tax code well enough to do his own taxes. Part of his defense, was, of course, that the code is too complex. Which is true, but in light of this, and his own errors, we might then hope he would be more aggressive about reforming the code, which he has not. The worst part of it, however, is the personal example he provided to the rest of the American taxpayers: do your taxes wrong, omit a few things, and if they catch you all you need is to pay it back — it’s basically okay.

I’m not calling for punishing Geithner (retribution isn’t necessarily helpful, not to mention it’s a little late), but as we draw closer to tax time, it’s worth recalling this incident and how it might affect the American public. In the research my colleagues and I have carried out on dishonesty, we’ve found repeatedly that people become more likely to lie and cheat after witnessing the dishonest behavior of others. In one of our experiments, we tested to see how participants would respond to a blatant act of dishonesty in their midst—would they think they too could cheat and get away with it, or would they perhaps straighten up and fly righter than ever? To find out, we gave participants 5 minutes to solve as many mathematical problems as possible (where they were instructed to find which two numbers out of 12 add up to 10).

In the control, where no cheating was allowed, the average student solved 7 problems, which gave them a pay off of $3.50 out of a maximum of $10 (if they solved all 20 problems). To see how witnessing and act of dishonesty would affect participants, we had one student—a confederate named David—stand up after only a minute and claim he’d solved all 20 matrices. The experimenter merely responded that in that case he could take his earnings and go. So how did the participants respond to this display when asked to self-report the number of matrices they solved? By cheating a whole lot: they claimed an average of 15 correct answers, more than twice the average score when cheating was not allowed.

Seeing someone cheat for their own benefit and then get away with it clearly has an impact on our moral behavior—loosening it to a substantial degree.

So, what does this experiment means for paying taxes? It means that the more we see politicians—the people who make our laws—fudge their taxes (which seems to happen continually), the more likely the rest of us are to adjust our understanding of what is right and wrong about paying our taxes, and do the same.

But there is hope.  When we ran the same experiment with one slight difference, we found that dishonesty decreased dramatically. This time, instead of looking like all the other participants, who were students at Carnegie Mellon University, we had our confederate wear a sweatshirt that located him within a different social group.  This time h was wearing a University of Pittsburgh sweatshirt (Carnegie Mellon’s neighboring and rival university). When the dishonest act was committed by a person from an out-group, we found that cheating decreased dramatically to the lowest level in all the experiments (participants claimed “only” 9 correct problems).

What this means is that if we think of ourselves and our politicians as being part of the same social group, we might follow their footsteps when we hear about another politician or celebrity who hasn’t paid taxes in years.  On the other hand, if we don’t think that we belong to the same social group we might not feel more justified in our own moral indiscretions, and instead be extra careful not to be confused with this other, not so moral, social group.

So the moral of the story is: when you settle in to work on your taxes in the next few weeks, try not to think about the individuals who cheat on their taxes—and if you can’t avoid thinking about them, at least try to separate your own social group from theirs.

Go forth and be financially virtuous.

Dan Ariely is the James B Duke professor of Psychology and behavioral Economics at Duke University and the author of (the soon to be released) The Honest Truth About Dishonesty.

I travel a great deal so I frequently find myself in the company of TSA agents who check my boarding pass, remind me to remove my shoes, jacket, belt, laptop, liquids, and all items from my pockets (including the previously inspected boarding pass), and then screen these things, as well as myself. Every time I find myself standing in line, in my socks, I inevitably contemplate the efficiency of the system. It’s only half an hour or so per flight, but when you multiply that number by all the people traveling in the United States, it’s a tremendous amount of time, effort, and money. And this comes not only from the TSA, but also in the form of lost productivity of all the people standing in line in various states of undress. One has to wonder whether it’s worth it.

It’s likely that on an individual level, we’re merely annoyed by the time and hassle of the present security routine, after all, it’s difficult to imagine how many resources are being used as you hurry through the lines. Lucky for us, this organization made a fantastic flowchart to help us see how much time and money we’re spending collectively on TSA, and, more importantly, what kind of results that investment is yielding. Judging from the price (over $60 billion) versus results (very few that are discernable), the question is: what do we do? Clearly we want to be safe and we want to prevent any terrorist activities, but it doesn’t seem that the current system is working, to say nothing of efficiency.

Perhaps in this situation, more is less. That is, maybe if we’re willing to give up more information about our travels and our lives, we’ll have to endure less time-consuming and haphazard scrutiny at the airport. For example, I recently had an interview with U.S. Customs and Border Protection as part of the Global Online Enrollment System (GOES), which preauthorizes approved frequent travelers to enter the US more quickly. I allowed them to do a background and credit check, and then met with an officer for an interview so that he could determine whether I posed any security risks (I’m happy to say I do not). Essentially, I opted for a reduction in privacy in return for not spending half an hour several times a week in line. For now it only applies to in-bound international flights, but I hope it will become more widespread.

At bottom, we have to give up some freedom and information in exchange for security. There’s no avoiding it. So the question is whether we want to do that in half-hour, invasive (not to mention ineffective) increments, or to go through a longer process once that looks further into our lives. Because the cost of the former comes is in small, redundant bits, we tend to overlook it, but in terms of hassle and time spent collectively, the second is a far better option.

That said, similar approaches to cutting time and money spent on security checks for domestic travel might be worthwhile. If individuals could agree to being tracked to a higher degree in order to gain quicker passage through security lines, it would allow TSA (or perhaps another group in charge of security) to know more readily who is and is not on flights. That way we could stop the inanity of having to take off our shoes, being x-rayed, and limiting liquids to theoretically non-explosive amounts.

After all, when you consider the approach to security so far, who knows what the next step might be—will we have to wear certain clothes only, carry only certain kinds of luggage, or no luggage at all? Instead we need a comprehensive approach that addresses concerns more fully, rather than the reactionary, piecemeal approach we have at present.