Property rights in sequential exchange

Arruñada, Benito; Zanarone, Giorgio; Garoupa, Nuno

doi:http://dx.doi.org/10.1093/jleo/ewy023

Property rights in sequential exchange

Citation

Arruñada B, Zanarone G, Garoupa N. Property rights in sequential exchange. The Journal of Law, Economics, and Organization. 2019 Mar;35(1):127-53. DOI: 10.1093/jleo/ewy023

Abstract

We analyze the “sequential exchange” problem in which traders have imperfect information on earlier contracts. We show that under sequential exchange, it is in general not possible to simultaneously implement two key features of markets—specialization between asset ownership and control, and impersonal trade. In particular, we show that in contrast with the conventional wisdom in economics, strong property rights—enforceable against subsequent buyers—may be detrimental to impersonal trade because they expose asset buyers to the risk of collusive relationships between owners and sellers. Finally, we provide conditions under which a mechanism that overcomes the tradeoff between specialization and impersonal trade exists. We characterize and discuss such mechanism. Our results provide an efficiency rationale for how property rights are enforced in business, company and real estate transactions, and for the ubiquitousness of “formalization” institutions that the literature has narrowly seen as entry barriers.