Does the Endowment Effect Justify Legal Intervention? The Debiasing Effect of Institutions

Abstract

We claim that the endowment effect rarely justifies legal intervention in private ordering. We present the first theory, to our knowledge, to explain how institutions inhibit the endowment effect without altering people’s rights to their entitlements. The endowment effect is substantially caused by anticipated regret. We show that people experience regret only when they feel responsible for the decision and can mute regret by trading through institutions that let them share responsibility with others. As entitlement holders typically transact through institutions, we expect most people to make unbiased trading decisions in real markets. We test two common institutions—agency relationships and voting—that divide responsibility between multiple actors. Each caused most subjects to debias and trade in our study. We also show that people intentionally debias by employing institutions in order to share responsibility. Thus, when people can freely transact, private ordering generally overcomes the endowment effect.

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