Moral Constraints, Social Norm Enforcement, and Strategic Default in Weak and Strong Economic Conditions

Abstract

We study the behavioral mechanisms which contribute to increased strategic defaults during an economic crisis. In our laboratory experiment, subjects can default on an outstanding loan, but moral constraints and social norm enforcement may provide incentives to repay. We exogenously vary the state of the economy: In the weak economy, more borrowers are forced to default than in the strong. We identify two main effects of weak economic conditions: First, moral constraints are softened: Solvent debtors default more often. Second, under informational uncertainty about the reason for default, social norm enforcement is undermined: Peers are more reluctant to sanction defaulters.