Authority, Risk Aversion, and Adaptation to Unforeseen Disturbances

Abstract

We introduce a model of the firm based on risk aversion. Non-risk-loving transacting parties adapt to completely unforeseen disturbances where authority (decision-making) structure is non-cooperatively determined. We demonstrate that working under a partner with a different preference for adaptative actions reduces uncertainty about which action is taken. Then, an authority relationship emerges when an appropriate adaptive decision is relatively unimportant and risk aversion is sufficiently high, whereas the welfare-maximizing authority structure remains independent of risk aversion. Furthermore, whereas lower risk aversion entails a higher probability of obtaining authority, a party with the lowest risk aversion may work under the partner.