Bounded Rationality and the Theory of Property

Oren Bar-Gill* & Nicola Persico**

Strong, property rule protection—implemented via injunctions, criminal sanctions, and supercompensatory damages—is a defining aspect of property. What is the theoretical justification for property rule protection? The conventional answer has to do with the alleged shortcomings of the weaker liability rule alternative: it is widely held that liability rule protection— implemented via compensatory damages—would interfere with efficient exchange and jeopardize the market system. We show that these concerns are overstated and that exchange efficiency generally obtains in a liability rule regime—but only when the parties are perfectly rational. When the standard rationality assumption is replaced with a more realistic bounded rationality assumption, liability rules no longer support exchange efficiency. Bounded rationality thus emerges as a foundational element in the theory of property.

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© 2019 Oren Bar-Gill & Nicola Persico. Individuals and nonprofit institutions may reproduce and distribute copies of this Article in any format at or below cost, for educational purposes, so long as each copy identifies the authors, provides a citation to the Notre Dame Law Review, and includes this provision in the copyright notice.

*William J. Friedman and Alicia Townsend Friedman Professor of Law and Economics, Harvard Law School (email: bargill@law.harvard.edu).

**Professor of Managerial Economics and Decision Sciences, Kellogg School of Management (email: nicola@nicolapersico.com). We thank Ronen Avraham, Omri BenShahar, Oliver Board, Rick Brooks, Ryan Bubb, Peter DiCola, Richard Epstein, Lee Fennell, Clay Gillette, David Gilo, Howell Jackson, Louis Kaplow, Lewis Kornhauser, Saul Levmore, Anup Malani, Yoram Margalioth, Alan Miller, Roger Myerson, Dotan Oliar, Gideon Parchomovsky, Michele Piccione, Ariel Porat, Eric Posner, Phil Reny, Ariel Rubinstein, Ira Rubinstein, Steve Shavell, Peter Siegelman, Joseph Singer, Henry Smith, Holger Spamann, Kathy Strandburg, Balazs Szentes, Eric Talley, Joel Watson, Asher Wolinsky, Stephane Wolton, and conference and workshop participants at Haifa University, Harvard University, New York University, Northwestern University, Tel-Aviv University, University of Chicago, University of Connecticut, the Annual Meeting of the American Law and Economics Association, and the Theoretical Law and Economics Conference for helpful comments. Michelle Adler provided excellent research assistance