Classification in Equilibrium: Structure of Optimal Decision Rules

Abstract: This paper characterizes optimal classification when individuals adjust their behavior in response to the classification rule. We model the interaction between a designer and a population as a Stackelberg game: the designer selects a classification rule anticipating how individuals will comply, cheat, or abstain in order to obtain a favorable classification. Under standard monotone likelihood ratio assumptions, optimal rules belong to a small and interpretable family (single-threshold and two-cut rules) that encompass both conventional and counterintuitive designs. Our results depart sharply from prior findings that optimal classifiers reward higher signals: in equilibrium, the designer may deliberately reward those with lower likelihood ratios or concentrate rewards/penalties in a middle band to improve informational quality.