Cognition and Governance Structure

Li Feng (Swedish University of Agricultural Sciences)
George Hendrikse (Rotterdam School of Management, Erasmus University)

Abstract: Boundedly rational agents commit type I and/or type II errors in the selection of projects. The incidence of these errors is to a certain extent determined by the governance structure. A governance structure is characterized as an allocation of cognitive units between the upstream and downstream agent. The governance structures Market, Cooperative, Forward Integration, and Backward Integration are distinguished. Each governance structure can be efficient, depending on the probability distribution of the states and the ratio of the payoffs of selecting the right and wrong project. We also show that the Cooperative is less (more) conservative in proposal selection than the other governance structures when the probability associated with the upstream states is below (above) a certain level.

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