Working Paper: CEPR ID: DP13054
Authors: Yair Antler
Abstract: We identify the conditions on the tendency of agents to spread information by word of mouth, under which a principal can design a pyramid scam to exploit a network of boundedly rational agents whose beliefs are coarse. Our main result is that a pyramid scam is sustainable only if its underlying reward scheme compensates the participants based on multiple levels of their downlines (e.g., for recruiting new members to the pyramid and for recruitments made by these new members). Motivated by the growing discussion on the legitimacy of multilevel marketing schemes and their resemblance to pyramid scams, we use our model to compare the two phenomena based on their underlying compensation structure.
Keywords: Pyramid scams; Multilevel marketing; Analogy-based expectations; Coarse feedback; Bounded rationality
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| multilevel reward scheme (M52) | sustainability of pyramid scams (D26) |
| one-level reward scheme (M52) | sustainability of pyramid scams (D26) |
| fully rational agents (D01) | participation of boundedly rational agents in pyramid scams (D80) |
| boundedly rational agents (D01) | participation in pyramid scams (K42) |
| tendency of agents to spread information (D82) | ability of scheme organizer to maintain pyramid scheme (L12) |