The Hindu Business Line : Of rotten-kids and family wealth

You may know about the devious behaviour of children who fight for their parents’ wealth. There have been movies and serials that thrive on this theme. One version goes like this: The children have their father transfer his wealth to them. After the wealth transfer, the sons and daughters ill-treat their parents and eventually disown them. My friend and I wondered if this happens in real life, until we met a couple who now live in an old-age home. Their story is similar to the one that you would see on TV. What has this got to do with economics? Parents who experience such situations, perhaps, have not heard about the Rotten Kid Theorem. What is it?

The theorem

Gary Becker, who won a Nobel Prize in Economics, designed this theorem. He suggests that family members will help each other if their financial incentives are interlinked, even if they are driven by selfish motives. What if the father decides that the “rotten kid” will receive money only if he treats his sister well? The “rotten kid” who would otherwise harm this sister now has an incentive to avoid harming her.

Maximising wealth

If you are wondering what that has to do with the old couple, simply extend the “Rotten Kid” argument further. Take a case where a father decides that his children will be bequeathed wealth only if he is taken care of, during his lifetime. What is more, the inheritance will be shared based on how much each child needs at that point in time. The first condition will ensure that the “rotten kid” will look after his parents during their lifetime, out of self-interest; otherwise, he may not even receive any money from the parents. Besides this, the “rotten kid” will ensure that his siblings accumulate substantial wealth on their own. Why? If the sibling earns more than him, the “rotten kid” will receive a larger share of the entire inheritance! And if all children turn out to be rotten kids, the family will be able to maximise its wealth, because each member may strive to increase the others’ wealth!

The old couple that we met obviously did not know about Gary Becker, but they sure did understand the logic behind the argument and regretted that they did not think about it.

(The author is a Chennai-based financial analyst.)

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