The Evolution of Investment Conventions

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Project Description for "The Evolution of Bargaining Conventions" byHerbert Dawid and W. Bentley Macleod Legal scholars and economic historians have long recognized theimportance of social conventions and norms for the efficient and smoothoperation of the economy. For example, if an employee feels that his orher employer is fair, then conflict is reduced, and the individual willinvest more into the relationship. However, it is extremely difficult toprecisely define the notion of a fair convention. One approach is to study the evolution of coventions in anexplicit bargaining problem where individuals have to decide how to dividethe gains from trade. The current literature has shown that the 50/50split is a stable convention in a variety of situations. That rule howeverdoes not reward individuals who may contribute more to a relationship, apoint that Grossman and Hart argue may explain why ownership is structuredto make one party a residual claimant to the profits of a firm. What hasnot been studied, and is the object of the current project, is theevolution of bargaining conventions in the presence of relationshipspecific investments. We show that that the addition of relation specific investmentscan result in social conventions that are very different from the 50/50split. Moreover, this research addresses an important open question raisedby Henry Hansmann and Reinier Kraakman, namely why is it efficient forownership to be concentrated in the hands of a single individual or group.We show that depending upon the information structure, both ownership andthe bargaining conventions evolve to a "fair rule" that encouragesefficient relationship specific investments, and low levels of conflict.In particular, we demonstrate that it depends crucially oncomplementarities between the specific investments of the individualswhether such fair and efficient conventions are developed. This work is theoretical and uses an abstract framework that mightnot be directly applicable in its current form. However, it does study theconditions that give rise to norms which encourage efficient behavior in adecentralized, anonymous economy. Understanding the structure ofefficient social norms may also have implications for the efficientrunning of exchange mediated through the internet. Elucidating the type ofinformation needed to ensure efficient exchange in these cases may help usbetter understand the rules that need to be used in "New Economy" toensure its continued success and growth.