While there are behavioral biases in entrepreneurial finance – e.g., entrepreneurs are overconfident and VCs fall prey to the availability heuristic – they don’t seem as prevalent as in public securities markets, or at least don’t lend themselves to the same calls for regulatory reform. Still, with recent notable works like Nudge and thought-provoking posts like this one from Josh Wright (on Jones v. Harris), it’s hard not to spend some time figuring out into which camp – rational choice or behavioral law and economics – you more firmly plant your flag.
The behavioral camp has much to offer. But several observations made by others persuade me not to dip my toes too deep into the behavioral waters. Here’s a quick list:
--Regulatory responses are challenging because different individuals have different biases, and even the same individual may have competing biases that negate each other;
--While individuals have biases, so do regulators (see Choi & Pritchard comparing the biases of investors with those at the SEC);
--The rational choice model works pretty well most of the time (and critics sometimes seem to forget that it’s only meant as a model, not a full-on reflection of the real world); and
--Taking into account behavioral biases in policy prescriptions removes incentives for correction. Tom Ulen has a nice discussion of this in a short article at 10 Lewis & Clark L. Rev. 177, 179-80 (2006) (it doesn’t appear to be on SSRN). There he differentiates between our “software” biases that can be corrected, including the entertaining Monty Hall three-door problem, and our “hardware” biases that are much harder to correct. Regulatory responses seem more appropriate for hardware biases, education for software biases.
There are also persuasive critiques of the rational choice model, and they get a lot of play these days. But regulatory responses based on the behavioral model are far from easy or perfect, and rational choice has proved highly instructive in my work on sophisticated entrepreneurial parties. I for one am not ready to toss it out just yet.
UPDATE: I should put this post in context, since the topic is like so 2005 (or whenever). I just finished Nudge (where have I been, I know!) and had sort of a negative gut reaction to it. To me the paternalism part overwhelmed any mitigating libertarian influence. I'm not a raging libertarian or anything, but I find myself uncomfortable with paternalism in many contexts. I'll get a chance to flesh out the issue more when Todd Henderson visits my class in a couple of weeks to talk about his provocative new paper The Nanny Corporation. Todd's paper first argues that paternalism for corporate employees is inevitable because stakeholders will demand it (e.g., to cut health care costs), then engages in a comparative analysis of who should supply it, markets or the state. I have doubts about the premise, but assuming its validity, I agree with Todd that markets are the preferential provider.
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