A Formal Behavioral Model of Firm Boundaries: Why Does Authority Relation Mitigate Ex Post Disputes over Trade Value?
Abstract: We explore why authority within firms helps trading parties immediately settle ex post disputes over trade value, which are invited by unprogrammed adaptation, despite the possibility of a subordinate's disobedience to the orders of his boss. By employing three crucial behavioral assumptions (reference-dependent preference, self-serving bias, and shading), we point out that the choice of governance structure affects trading parties' expectations about outcome of ex post value split and show that a subordinate is likely to obey orders of his boss because he is expected to do so. Nevertheless, our study also points out that such a positive aspect of authority comes with subordinate's psychological disutility.
