The Evolution of Investment Conventions

University Of Southern California, Los Angeles CA

Investigators

Abstract

Project Description for "The Evolution of Bargaining Conventions" by Herbert Dawid and W. Bentley Macleod Legal scholars and economic historians have long recognized the importance of social conventions and norms for the efficient and smooth operation of the economy. For example, if an employee feels that his or her employer is fair, then conflict is reduced, and the individual will invest more into the relationship. However, it is extremely difficult to precisely define the notion of a fair convention. One approach is to study the evolution of coventions in an explicit bargaining problem where individuals have to decide how to divide the gains from trade. The current literature has shown that the 50/50 split is a stable convention in a variety of situations. That rule however does not reward individuals who may contribute more to a relationship, a point that Grossman and Hart argue may explain why ownership is structured to make one party a residual claimant to the profits of a firm. What has not been studied, and is the object of the current project, is the evolution of bargaining conventions in the presence of relationship specific investments. We show that that the addition of relation specific investments can result in social conventions that are very different from the 50/50 split. Moreover, this research addresses an important open question raised by Henry Hansmann and Reinier Kraakman, namely why is it efficient for ownership to be concentrated in the hands of a single individual or group. We show that depending upon the information structure, both ownership and the bargaining conventions evolve to a "fair rule" that encourages efficient relationship specific investments, and low levels of conflict. In particular, we demonstrate that it depends crucially on complementarities between the specific investments of the individuals whether such fair and efficient conventions are developed. This work is theoretical and uses an abstract framework that might not be directly applicable in its current form. However, it does study the conditions that give rise to norms which encourage efficient behavior in a decentralized, anonymous economy. Understanding the structure of efficient social norms may also have implications for the efficient running of exchange mediated through the internet. Elucidating the type of information needed to ensure efficient exchange in these cases may help us better understand the rules that need to be used in "New Economy" to ensure its continued success and growth.