The Tyranny of the Inefficient: An Enquiry into the Adverse Consequences of Power Struggles

36 Pages Posted: 17 Jun 1998

See all articles by Luigi Zingales

Luigi Zingales

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Date Written: April 1997

Abstract

There are many instances where two closely related parties do not agree to mutually advantageous transactions even when there are simple enforceable contracts, and side transfers of fungible resources, that would implement them. Peace treaties are not signed, inefficient regulations are not altered, and possibilities for investment are frittered away. One reason, which has been extensively analyzed in the literature, is the presence of informational asymmetries. In this paper we focus on another potential explanation: the externality generated by the transfer of fungible resources. Unlike in a one-off transaction among unrelated parties, related parties will interact in the future. The very fungibility of the resources that are transferred to facilitate the immediate transaction can make it hard to restrict their use. As a result, if future interactions are influenced by the distribution of current resources, an externality can endogenously arise from the current transaction. Under some circumstances, even transactions that considerably enhance value can be inhibited by the endogenous externality. Agreement typically breaks down when the required transfer is large and the proposed recipient of the transfer is relatively unproductive or poor. The paper examines the implications for a theory of property rights, and for competitive strategy.

JEL Classification: D23, G30, L22

Suggested Citation

Zingales, Luigi and Rajan, Raghuram G., The Tyranny of the Inefficient: An Enquiry into the Adverse Consequences of Power Struggles (April 1997). Available at SSRN: https://ssrn.com/abstract=7217 or http://dx.doi.org/10.2139/ssrn.7217

Luigi Zingales

University of Chicago - Booth School of Business ( email )

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Raghuram G. Rajan (Contact Author)

University of Chicago - Booth School of Business ( email )

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