The One who Gives Too Early, Gives Twice: Cooperation, Blood Feuds and Third-Party Institutions

Third-party institutions (judges, real-estate agents, referees, mediators, and arbiters) are designed to avoid mis-coordination among potential cooperators. They differ from first-party institutions (lobbyists) who act as rent-seekers in bargaining. They also differ from second-party institutions (auditors) who act as monitors in principal-agency problems. Third-party institutions are geared to minimize distorted belief formation, which arises from the uncertainty of how to judge the over-contribution of others: Is it the outcome of a positive income shock or is it expressive of real income being higher than estimated income? Given positively skewed income distribution and bounded rationality, such uncertainty leads to mis-judgments of the contribution of others as “unfair,” leading to the collapse of cooperation.