Property Rights in Sequential Exchange

From Coase (1960) to Akerlof (1970), Williamson (1979), and Grossman and Hart (1986), economic models assume that transactors are well informed on the allocation of property rights prior to contracting. While this assumption is useful to keep formal analysis tractable, it contradicts the reality of modern markets. Thus, a buyer of assets may not know whether she is buying from the owner, an authorized agent of the owner, a non-authorized agent, or even a fraudulent seller. Similarly, a company’s client, supplier, or investor, may ignore whether the manager she is dealing with has been previously authorized by shareholders to conduct that particular business on behalf of the company. As a result, transactors may acquire rights over an asset that are inconsistent with a prior allocation of rights established by potentially hidden contracts.

This article studies property rights in this realistic “sequential exchange” environment, where the acquirer of rights over an asset may not know whether the agent selling those rights has been authorized to do so by the owner, an essential element in productive specialization.

In this setting, a key feature of property rights is that they can be enforced against subsequent buyers. This has been largely ignored in the economic literature by assuming that economic agents enjoy unlimited liability.

We fill this gap by showing that under sequential exchange, in a setting where agents suffer from limited liability, the central question is who should be allocated an asset in case of conflict—that is, whether owners’ rights over the asset should be enforced against subsequent buyers, as “property rights”, or only against the seller, as “personal rights”. We show that under these polar institutional regimes, it is in general not possible to simultaneously support two key features of markets—namely, specialization of asset ownership and control, and impersonal trade.

In particular, we show that in a world where asset owners’ property rights are strictly enforced, these may use their personal relationships to secretly collude with agents against unrelated future acquirers of the assets, who will therefore not buy in anticipation of such collusion. In other words, relational contracts between owners and agents may crowd out impersonal subsequent contracts between agents and third parties. At the same time, however, if owners’ property rights are not enforced, they will not delegate control of their assets to agents unless they have a tight relationship with them, hampering both efficient specialization and trade.

We conclude our analyzing institutions that support both specialization and trade. Our model thus provides a unified rationale for the institutional underpinnings of specialization and the separation of ownership and control—a central feature of market economies at least since the analysis of Adam Smith (1776). In particular, our model highlights how specialization is made possible by a panoply of complex and sometimes misunderstood institutions, such as adverse possession, the rules on good faith purchase, and property and company registries. Our model also provides an analytical framework that may be useful to adapt these institutions without hampering their fundamental market-preserving function.

Source: Arruñada, Benito, Giorgio Zanarone, and Nuno Garoupa (2019), “Property Rights in Sequential Exchange,” Journal of Law, Economics, and Organization, 35(1), 127-53.