Delegation Economics

Delegation Economics

Trust Production Function

How is trust produced? What are the inputs?

Inputs to trust production:

• Time (trust builds slowly)
• Information (observations of behavior)
• Verification (testing, auditing, proving)
• Structure (architectural constraints)
• Reputation (third-party attestations)

Production function:

Trust = f(time, information, verification, structure, reputation)

Properties:

• Increasing in all inputs (more of any → more trust)
• Diminishing returns (harder to increase high trust)
• Complementarities (verification more valuable with information)

Trust Depreciation

Trust as capital stock that depreciates:

Trust(t+1) = Trust(t) × (1 - depreciation) + Investment(t)

Depreciation causes:

• Memory decay (forget past evidence)
• Context change (old evidence less relevant)
• Capability change (agent abilities shift)
• Threat evolution (new attacks discovered)

Steady state: Trust stabilizes when investment = depreciation

Trust* = Investment / depreciation

Higher depreciation → need more investment to maintain trust.

Trust Arbitrage

If trust is mispriced, arbitrage opportunities exist:

Scenario: Market undervalues Agent A’s trustworthiness

• A requires trust premium to be hired
• Principal knows A is actually more trustworthy
• Principal can “buy” A’s services cheap, capture value

Reverse scenario: Market overvalues Agent B

• B demands low trust premium
• Principal hires B, suffers trust violation
• Loss to principal

Market efficiency: In efficient trust markets, prices reflect actual trustworthiness.

Market Failures

Information asymmetry (agent knows own trustworthiness, principal doesn’t), adverse selection (untrustworthy agents willing to work for less), and moral hazard (agent behavior changes after trust granted).

Trust Insurance

Deep Dive

For extensive coverage of how the insurance industry actually prices defection risk, see Fidelity Insurance: Pricing Defection Risk.

Insurance structure:

• Principal pays premium P
• If trust violation causes damage D, insurer pays D
• Insurer prices premium: P = E[D] × P(violation) × (1 + margin)

Insurer incentives:

• Verify trustworthiness before insuring (underwriting)
• Monitor during coverage (loss prevention)
• Recover from violator after loss (subrogation)

Moral hazard: With insurance, principal might be less careful about trust.

Mitigation:

• Deductibles (principal bears first $X of loss)
• Co-insurance (principal bears Y% of loss)
• Experience rating (premium depends on past claims)

Trust Derivatives (Speculative)

Trust future: Contract to buy/sell trust capacity at future date

• “I commit to trusting you for X tasks in Q3 at trust level Y”

Trust option: Right but not obligation to grant trust

• “I can grant you trust for deployment if you pass evaluation”

Trust swap: Exchange trust obligations

• “I’ll trust your agent for my tasks if you trust my agent for yours”

Trust and Incentive Compatibility

Revelation principle applied to trust:

For any mechanism achieving trustworthy behavior in equilibrium, there exists a direct mechanism where reporting true trustworthiness is optimal.

Tip

Implication: can focus on designing mechanisms where honest trust reporting is incentive compatible. This is the core insight enabling principled trust markets.

VCG for trust allocation:

• Agents report trust requirements for tasks
• Tasks allocated to minimize total trust
• Payments make truthful reporting dominant strategy

Payment rule:

Payment_i = Trust_cost_to_others_if_i_absent - Trust_cost_to_others_with_i

Agent pays based on externality they impose on others.

Trust Market Design

Desirable properties:

1. Efficiency: Trust allocated to highest-value uses
2. Truthfulness: Honest reporting is optimal
3. Individual rationality: Participation is voluntary and beneficial
4. Budget balance: Payments in ≥ payments out

Challenges:

• Trust is not perfectly fungible
• Verification is costly
• History matters (reputation effects)
• Trust failures have externalities

Potential mechanisms:

• Posted prices for trust services
• Auctions for trust-requiring tasks
• Reputation systems with economic stakes
• Insurance markets for trust violations