Coalition Formation with Cooperation-Enhancing Transfers When Players Are Heterogeneous and Inequality-Averse

Obtaining significant levels of cooperation in public goods and environmental games, under the assumption of players being purely selfish, is usually prevented by the problem of free riding. Coalitions, in fact, generally fail to be internally stable, and this causes a serious under-provision of the public good, together with a significant welfare loss. The assumption of relational preferences, capable of better explaining economic behaviours in laboratory experiments, helps to foster cooperation, but, without adequate transfer scheme, no substantial improvements are reached. The present paper proposes a cooperation-enhancing transfer scheme under the assumption of players having Fehr and Schmidt utility functions, whose objectives are to guarantee internal stability and to maximize the sum of the utilities of coalition members. The transfer scheme is tested on a public goods contribution game parameterized on the data provided by the RICE model and benchmarked with other popular transfer schemes in environmental economics. The proposed scheme outperforms its benchmarking counterparts in stabilizing coalitions, and sensibly increases cooperation compared to the absence of transfers. Furthermore, for high but not extreme values of the parameter governing the intensity of dis-utility from disadvantageous inequality, it manages to support very large coalitions.