A Test of Dominant Assurance Contracts

The free rider problem is a challenge to the market provision of public goods. In my paper on dominant assurance contracts I use game theory to show how some public goods can be produced by markets using a special contract. In an assurance contract people pledge to fund a public good if and only if enough others pledge to fund the public good. Assurance contracts were not well known when I began to write on this topic but have now become common due to organizations like Groupon and Kickstarter which work on this principle (indeed, I have been credited with the ideas behind Groupon although sadly for my bank account I don’t think that claim would stand in a court of law). Since no money is paid unless the total pledges are high enough to fund the public good, assurance contracts remove the fear that your contribution will be wasted if other people fail to contribute. However, if you don’t believe that others will pledge there is no reason for you to pledge and if you don’t pledge others have no reason to pledge either so your beliefs will turn out to be accurate. With even low transaction costs the no pledge equilibrium seems quite likely.

What a dominant assurance contract adds is that the entrepreneur agreeing to produce the public good if k or more pledge also agrees that if fewer than k pledge he will pay a prize to those who did pledge. Pledging is now a no-lose proposition–if enough people pledge you get the public good and if not enough pledge you get the prize. A contract like this makes it a dominant strategy to pledge and so the public good is funded. (See the paper for details).

Recently Jameson Quinn tried the idea out with a campaign on Quora. The public good was to contribute to The Center for Election Science. Each pledger agreed to give $60 to the Center if 20 or more similarly pledged and Jameson agreed that if fewer than 20 pledged he would give each person who did pledge $5 and they would have to pay nothing. (This is the essence, Jameson actually modified the dominant assurance contract to offer slightly different terms at 19 and over 20. He has some interesting ideas on this score, see the post for details). So what happened?

Success! It was a nail-biter as the final 3 pledges came in only in the last half hour. Remarkably, the lure of $5 for nothing helped to produce a public good which the pledgers all wanted but might not have produced had the incentive to free ride not been counteracted.

Kickstarter has made assurance contracts familiar, perhaps the next evolution of funding mechanisms will do the same for dominant assurance contracts.