A Formal Behavioral Model of Firm Boundaries: Why Does Authority Relation Mitigate Ex Post Adaptation Problems?
47 Pages Posted: 29 Jan 2013
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A Formal Behavioral Model of Firm Boundaries: Why Does Authority Relation Mitigate Ex Post Disputes over Trade Value?
Date Written: January 22, 2013
Abstract
We explore why authority within firms helps trading parties immediately settle ex post adaptation problems despite the possibility of a subordinate's disobedience to the orders of his boss. By employing three crucial behavioral assumptions (reference-dependent preference, self-serving bias, and shading), we point out that the choice of governance structure affects trading parties' expectations about outcome of ex post adaptations and show that a subordinate is likely to obey orders of his boss because he is expected to do so. Nevertheless, our study also points out that such a positive aspect of authority comes with subordinate's psychological disutility.
Keywords: Reference-dependent preference, self-serving bias, contracts as reference points, transaction cost, ex post adaptation
JEL Classification: D23, L22
Suggested Citation: Suggested Citation
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