This chapter, written for a volume on Hidden Fallacies in Corporate Law and Financial Regulation, argues that markets and market actors can be better understood by taking into account some neglected determinants of behavior, motivations and beliefs -- and ultimately, by embracing an expanded view of rationality. The neglected determinants are tribes, by which I mean communities with their own norms, rituals, and institutions, and temperament, which I use in its colloquial sense. Deal makers, for instance, can be said to have a community, with norms as to, among other things, ‘what’s market.” Knowing and abiding by the norms conveys information about a person’s willingness and ability to function as a member of the community. The community anoints certain experts who pass muster as experts for purposes of community judgments. Interestingly, the status as anointed expert can be sticky notwithstanding significant disconfirming evidence, as demonstrated by the continuing high market shares of the major rating agencies. Temperament figures in when a less confident investor, even a “sophisticated” institutional investor, rushes to buy “a hot new issue” because it is hot, notwithstanding ample cautionary disclosure. Temperament also figures in when a banker designs a financial instrument or sales strategy that honors the letter of the law while arguably violating its spirit. The chapter discusses temperament on two different dimensions: greater or lesser degrees of confidence in one’s own judgments, including, at the extremes, the least confident and the contrarians, and “regulatory focus,” a concept developed by psychologist and business school professor Tory Higgins, which distinguishes “prevention” focus (more vigilant, hate to lose) from “promotion” focus (less vigilant, love to win). My arguments succeed, or not, by persuasion rather than proof – it’s not clear what proof would look like in any event. Certainly, the personality types I describe are well-known, in the literature and in real life, as are, at some level of generality, the social dynamics I describe, such as herding, and the existence of market communities, broadly construed, that have norms, rituals and institutions. My burden is more to show that taking tribes and temperament into account in analyses of market behavior is feasible and desirable, and that not doing so unnecessarily sacrifices realism. Since around the mid-‘90s, there has been a push to make economics, and law and economics, more realistic. Exploring the neglect of tribes and temperament and how this could be remedied can be an effective means of doing so: rather than characterizing ways in which people are less rational than law and economics assumes them to be, law and economics can instead reconceive what rationality requires. The re-conception of rationality should, in my view, be radical as to economics’ ontology but not as to its conceptual toolbox. Underlying the standard economics worldview is a metaphorical or perhaps literal acceptance of the credo ‘survival of the fittest.’ But an alternative view, advanced by philosopher Daniel Milo, ‘survival of the good enough,’ seems far more plausible. Without the specter of extinction, many more courses of action become viable. Of course, if we try to fully capture the nuances, we will lose all possibility of a tractable theory. But we can do far better than we do now, by taking into account three things: that we live in a world of uncertainty (“unknown unknowns”), not just risk; that our cognitive capacity is limited; and that how people react to uncertainty and cognitive limitations turns on who they are and how they view themselves.
Read full abstract
Mar 2, 2023
Ran Chen 
Open Access
