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PLAYING 'CHICKEN' WITH RISK

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Monday, June 9, 2008

Duke University marketing professor Debu Purohit studies "moral hazard" -- the idea that when people are protected against risk, they take chances they might avoid if they had to face the music. Purohit understands moral hazard not only as someone who has studied the effects of anti-lock brakes on passenger driving but also as a parent.

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Purohit said his daughter was consistently late getting ready for school. This meant he had to drop her off at school, which made him late, too. Repeated entreaties and threats made no difference, because the child perceived -- accurately -- that Purohit did not really have the option of leaving her alone at home and going off to work.

As government officials discovered when the Wall Street firm Bear Stearns nearly went under, there are times when it can be irresponsible to allow people to face the music. It would be absurd, for example, to tell drunk drivers that ambulances will not be sent to help them if they get into accidents.

"The issue is credibility," Purohit said. "In movies, the guy says 'Tell me where the golden goose is, or I will kill you!' and the other person says 'If you kill me, you will never find out!' People try this logic on the street and sometimes it works and sometimes it doesn't. My kid figured out my threat was not credible."

Purohit settled on a compromise similar to what federal bankers recently did with Bear Stearns -- they kept the firm from collapsing, but on terms that were harsh to company officials and investors who had taken on too much risk. The next time his daughter dawdled, Purohit took her to . . . his office. Then, to her dismay, he dropped her off at school at 11.

Purohit's daughter got ready on time the next day. He mused: "You have to act slightly crazy to get them to believe you will follow through."


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