Private Ordering and Cognitive Psychology

Jan 13, 2014 — Neil Boyle

Studies in cognitive psychology support the development of credible commitment and private ordering in three respects: (i) that people’s responses to risky situations depend directly on emotional influences such as worry, dread, or anxiety, responses of the primitive part of the brain rather than the cortex [1] (Shiller, 2003, p. 88); (ii) that people have a fundamental preference for consistency, a fundamental urge to be true to their principles and beliefs, and tend to experience negative emotion when they feel that they have been inconsistent. This tendency was discovered and named by Psychologist Leon Festinger, 1957) “cognitive dissonance” as cited in Shiller, 2003, p. 91); and (iii) that a basic human behavior pattern is a preference for reciprocity. [2] People tend to want to do kind acts if they view themselves as treated kindly, and to do hostile acts if they view themselves as treated badly.  A sense of reciprocity is important for many financial innovations for it can enhance stability through time. (Shiller, 2003, p. 92).  Professor Shiller was awarded the Nobel Prize for Economics in 2013.

Think of private ordering in terms of court ordering as the means of bringing order or stability to a transaction. We are familiar with the court as the final appeal for any contract.  Final appeal refers to the appeal one resorts to when nothing else has worked.  But what happens in the interim before the time for final appeal?  Surely, final appeal includes termination as a possible outcome, which is not a desirable outcome under most investment (as compared to purchase) circumstances.  Private ordering is the solution to conflict that is designed and agreed to by both parties to a contract before the hatchet falls.

Organizational capacity relations between buyers and suppliers mirror the incentive structure of giving and taking credible commitment and its derivative of private ordering and reciprocity. For example, buyers secure better terms from suppliers by giving suppliers relief from demand cancellation penalties.  Contracting parties’ (e.g., outlier farmers) secure better terms from counterparties (e.g., core operations) by “giving” counterparties credible relief from opportunism.

Private ordering, credible commitment and reciprocity go hand in hand.  Credible commitment perforce speaks to the existence of private ordering in the immediate histories of the parties involved.  The question is how to create these histories?  The answer is for one party to initiate giving credible commitments to the other party by making a credible offer and waiting for a reply.  The absence of a reply is information that did not exist before.

 

 


[1] Purely intellectual recognition of risks does not lead to action against the risk but must be accompanied by emotional content. The frontal lobe of the cortex transforms images of absent events into experiences of pleasure or discomfort. Frontal lobotomy patients, for whom part of the brain in this area has been removed, seem always confined in their attention to the present, blithely unconcerned about any distant risks.

[2] See Ernst Fehr and Urs Fischbaher, “Why Social Preferences Matter—The Impact of Non-Selfish Motives on Competition, Cooperation and Incentives,” paper presented at Nobel Symposium on Behavioral and Experimental Economics, 2001.

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  1. Here are some thoughts. Think of private ordering in terms of court ordering as the means of bringing order or stability to a transaction. We are familiar with the court as the final appeal for any contract. Final appeal refers to the appeal one resorts to when nothing else has worked. But what happens in the interim before the time for final appeal? This is when private ordering obtains. Simply put, private ordering is the solution to conflict that is designed and agreed to by both parties to a contract.

    By Neil Boyle - April 3rd, 2014 at 3:08 pm

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