Endogenous Peer Punishment Institutions in Prisoner’s Dilemmas: The Role of Noise

We study six-person Prisoner’s Dilemmas (PDs), in which subjects endogenously decide whether to implement a peer punishment institution in their group and whether the punishment institution, if implemented, implies more or less severe punishment. We consider PDs with perfect information on other subjects’ previous behavior and PDs in which subjects observe each other’s behavior with noise. We expect subjects to be less inclined to implement a punishment institution and to be less likely to prefer severe punishments with noise than without noise.We find that, without noise, the majority of groups choose a punishment institution with severe punishments. With noise, most groups do not implement a punishment institution. Both with and without noise, cooperation and earnings increasewhen a punishment institution is implemented, especially with opportunities for severe punishments. However, subjects in the noise condition perceive lower earnings under severe punishments than under the other options.With noise,moreover, observing the punishment of cooperators discourages subjects fromimplementing a punishment institution in subsequent interactions.