Institution Formation In Public Goods Games

Centralized sanctioning institutions are of utmost importance for overcoming free-riding tendencies and enforcing outcomes that maximize group welfare in social dilemma situations. However, little is known about how such institutions come into existence. In this paper the authors investigate, both theoretically and experimentally, the endogenous formation of institutions in a public goods game. The theoretical analysis shows that players may form sanctioning institutions in equilibrium, including those where institutions govern only a subset of players. The experiment confirms that institutions are formed frequently as well as that institution formation has a positive impact on cooperation rates and group welfare.