Choice over Choice-restricting Institutions

Mark Adams

Major Professor: Charles K. Rowley, Department of Economics

Committee Members: Peter Boettke, Todd Zywicki

Enterprise Hall, #318
April 29, 2013, 10:00 AM to 07:00 AM


Human behavior is shaped by the rules we impose on ourselves and those that are imposed on us.  These rules can overcome limited cognitive abilities but are themselves constructed by boundedly rational humans. This dissertation examines rule selection over three spheres: social exchange, corporate governance, and the law, and presents a framework for comparing approaches to rule formation.

The first essay develops a theory of voluntary choice-restriction through social exchange. I review evidence for neoclassical choice theory, behavioral choice theories, and alternative theories in economics, neuroscience, and evolutionary psychology. While biases exist there are multiple strategies for aligning choice and true preferences. Humans have specific evolutionary programming for social exchange which can be used to frame choices.  I present a model of social exchange in which boundedly rational individuals can efficiently choose a system of error-reducing rules by selecting over bundles of rules. I further show that over a significant range of cases this is more efficient than using designed rules.

The second essay extends the analysis to firms. I respond to both agency-based and behavioral critiques of the market-financed firm, arguing that a theory of bounded rationality is implicitly a theory of knowledge. Firms must be capable of innovating and responding to external change. I propose a model of choice-restriction within firms which incorporates learning, radical innovation, and investment under uncertainty. I compare competing ownership structures and argue that the market-financed corporation is an efficient response to bounded rationality and dynamic uncertainty. This ownership structure uniquely permits the firm to alter its form (morphogenesis) to either rigidity or flexibility. This allows the firm to conserve knowledge and reduce transaction costs but still respond to changing external market conditions.

The third essay examines the role of federalism and competition in the law. Theories of bounded rationality admit a role for the law in regulating relations between investors and firms, but political markets are limited by the same features which constrain effective monitoring by investors. This paper proposes a model of choice restriction in which decentralized governments use both internal (constitutional) and external (federalist) institutions to commit to providing good law in unknown future states of the world.  I present a model of jurisdictional competition with semi-immobile capital.  Parties who commit to a jurisdiction under uncertainty rely on institutional commitments to provide efficient future law and guarantee property rights. I show that under certain conditions, competition under federalism will provide the most effective response to crises and may reduce some externalities associated with risk-bearing.