Why are people trapped in Ponzi and pyramid schemes?
| Published date | 24 August 2020 |
| DOI | https://doi.org/10.1108/JFC-05-2020-0093 |
| Date | 24 August 2020 |
| Pages | 187-203 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial crime |
| Author | Taofik Hidajat,Ina Primiana,Sulaeman Rahman,Erie Febrian |
Why are people trapped in Ponzi
and pyramid schemes?
Taofik Hidajat
Department of Management, Sekolah Tinggi Ilmu Ekonomi Bank BPD Jateng,
Semarang, Indonesia and Faculty of Economics and Business,
Universitas Padjadjaran, Sumedang, Indonesia, and
Ina Primiana,Sulaeman Rahman and Erie Febrian
Faculty of Economics and Business, Universitas Padjadjaran,
Sumedang, Indonesia
Abstract
Purpose –This paper aims to identify psychologicalfactors that influence people to be involved in Ponzi
and pyramidschemes.
Design/methodology/approach –A psychological approach to finance or behavioural finance is
applied in this research because of the assumptionthat human beings are not always rational. The sample
consisted of 98 investorsin 11 cities in Indonesia who were or had invested in an investment program witha
Ponzi or pyramidscheme. The snowball sampling techniquewas applied.
Findings –The conclusion is that optimism (emotional bias), confirmation bias, representativeness bias,
framing bias and overconfidence (cognitivebias) positively influenced investment decisions related to Ponzi
and pyramidschemes.
Originality/value –The novelty aspect of this research is the implementation of a behavioural finance
perspectiveto answer and express the fascinating phenomenon of Ponzi and pyramidinvestment schemes.
Keywords Behavioural finance, Ponzi scheme, Cognitive bias, Emotional bias, Pyramid, scheme
Paper type Research paper
1. Introduction
Ponzi and pyramid investment schemes are “get rich quick schemes”that exist alongside other
legal investment schemes. Both are investment scams because of the profit given to investors
taken from new investors’funds. They are always a money game. Both systems can be found
in almost all countries around the world. Prominent cases are present in Malaysia, Papua New
Guinea, China, Russia, Bulgaria, Romania, Caribbean, Serbia, USA, Slovakia, Czech Republic,
Albania and so on. In Indonesia, existing Ponzi and pyramid schemes are part of the list of
illegal investments released by the Financial Services Authority.
Through the internet, fraudulentinvestment schemes often arises through the High Yield
Investment Programs (HYIP). HYIP appears on the websites making offers to investors
interested in multiplying their funds with high yields in a specified period. The return
promised is very high and more than the profit obtained from fixed income instruments.
According to Moore et al. (2012), HYIP is “postmodern investment”because, actually,
investors are aware of fraudulentpractices by schemers, but they still join in it because they
expect to get benefitsby joining earlier.
Special thanks to Tongam L. Tobing, Chair of the Investment Alert Task Force, and Dhani Gunawan
Idat from Financial Services Authority (OJK), for valuable discussions and suggestions.
Ponzi and
pyramid
schemes
187
Journalof Financial Crime
Vol.28 No. 1, 2021
pp. 187-203
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-05-2020-0093
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1359-0790.htm
The victims of this kind of tricky scheme are not only people who have a lot of money
and are highly educated (Hidajat, 2018), but they were also people who live at an average
level and have a low level of educated. The most significant adverseimpacts of this kind of
spurious scheme occur in many countries with the weak regulation systems. The most
dramatic event occurred in Albania. When the investment schemes had collapsed in 1996,
riots and massive anarchy toppled the existing regime and killed more than 2.000 people
(Monroe et al., 2010).
This research was conducted to identify psychological factors that influenced people’s
decisions to invest in Ponzi and pyramids schemes.Reurink (2016) stated that in the various
literature on investment and financial scams, the interesting question is always, What
factors lead the people to make irrational decisions to participate in a scam investment?
Specifically, this research was conducted to examine the influence of emotional and
cognitive bias on investmentdecisions related to Ponzi and pyramids schemes.
The psychological approach to finance was applied in this study because humans are not
always rational when making their decisions, especially when they are influenced by various
emotional aspects, including when deciding to invest in Ponzi and pyramid schemes.
According to Statman (2014), irrational investors are no different from ordinary investors.
Normal investors are affected by cognitive and emotional biases. In some studies, cognitive and
emotional biases have been proven to play a role in investment decision-making. Fairchild
(2014) stated that when a decision is affected by emotional bias, then the cognitive process
responds, upon which, finally, an investor makes irrational actions or decisions.
The novel aspect of this study is the implementation of a behavioural finance approach
or perspective to answer and express the fascinating phenomenon of Ponzi and pyramid
investment schemes. The behavioural bias was the unusual factor that caused investors to
invest in both types of investment schemes. Behavioural finance assessment of the
behavioural bias of investors is considered a proper discussion domain for studying
irrational investorbehaviour.
Studies explaining why investors are still interested in joining such investment schemes are
still rare. This was the reason why Eisenberg and Quesenberry (2014) suggested carrying out
studies to expose the real factors motivating people to join these systems. Some studies have
discussed factors causing investors to enter the pyramid schemes (Mackenzie, 2005), Ponzi
schemes (Blois and Ryan, 2013;Deason, 2012;Jacobs and Schain, 2011;Lewis, 2012;Stolowy
et al., 2014;Tennant, 2011;Wilkins et al., 2012), and online scams (Button et al.,2014).However,
the results of these studies were based primarily on a psychological approach.
Shiller (2000) stated that Ponzi schemes elicit irrational exuberance, and it described
psychological behaviour in which people act irrationally. Lewis (2012),Elan (2010) and
Greenspan (2008) also stated that a psychological approach could provide a better answer
for understanding reasons why people get involved in this kind of scheme. Pressman
(1998b) had also stated that empirical psychological factors can be used to analysed how
people make decisions when they faced uncertainty; such factors could provide better
explanations than those given by several neoclassical economists who emphasized the
consequences of informationasymmetry in explaining the success of Ponzi schemes.
2. Ponzi and pyramid schemes
Ponzi and pyramids schemes are terms that are often used interchangeably (Cunha et al.,
2013;Deason, 2012).Both investment schemes have similarities. The similarityis that return
or profit given to an investor is derived fromthe money deposited by others who just joined
(Benson, 2009;Wilkins et al.,2012), and generally, it is not derived from real investment
activities (Lewis, 2012). In a Ponzi scheme, an investor only needs to give money to the
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