Boundedly Rational Entrepreneurs and Antitrust

Date01 December 2016
Published date01 December 2016
ABX673948 520..540 Article
The Antitrust Bulletin
2016, Vol. 61(4) 520-540
Boundedly Rational
ª The Author(s) 2016
Reprints and permission:
Entrepreneurs and Antitrust
DOI: 10.1177/0003603X16673948
Avishalom Tor*
This article examines entrepreneurial activity and its implication for policy and antitrust law from a
behavioral perspective. In particular, the analysis here focuses on the role of two sets of behavioral
phenomena—overconfident beliefs and risk-seeking preferences—in facilitating boundedly rational
entrepreneurship. Boundedly rational entrepreneurs may engage in entrepreneurial activity, such as
the starting of new business ventures, under circumstances in which rational entrepreneurs would
decline to do so. Consequently, overconfident or risk-seeking entrants compete with their more
rational counterparts and create a post-entry landscape that differs markedly from the picture
assumed by traditional economic accounts of entrepreneurial activity. The behaviorally informed
analysis of entry sheds new light on the dynamics of competition among entrepreneurs and on its
implications for policy and antitrust law.
rationality, bounded rationality, risk-seeking, overconfidence, optimism, entry
I. Introduction
Entrepreneurship is a complex and multifaceted phenomenon that defies a simple, single definition, as
the other articles in this symposium make clear.1 Scholars noted that ‘‘[e]ntrepreneurship has meant
different things to different people,’’2 beginning with historical definitions identifying the term with
self-employment with uncertain returns.3 Schumpeter, for instance, viewed entrepreneurs as those who
carry out new combinations, creating new products, processes, markets, organizational forms, or
1. See generally Greg Gundlach, Introduction: Broadening the Lens—Entrepreneurship & Antitrust, ANTITRUST BULL. (2016,
this issue).
2. Pramodita Sharma & James J. Chrisman, Toward a Reconciliation of the Definitional Issues in the Field of Corporate
Entrepreneurship, 23 ENTREPRENEURSHIP THEORY & PRAC. 12 (1999).
3. Wayne Long, The Meaning of Entrepreneurship, 8 AM. J. SMALL BUS. 47, 47 (1983) (citing the eighteenth-century usage of
*Notre Dame Law School, Notre Dame, IN, USA; and University of Haifa, Faculty of Law, Israel
Corresponding Author:
Avishalom Tor, Notre Dame Law School, Notre Dame, IN 46556, USA.

sources of supply.4 For the sake of clarity, however, the present article focuses on one common and
important form of entrepreneurship—the creation of new business ventures in manufacturing
Traditional economic models assume rational entrepreneurship, expecting new ventures to be
created only when it is profit maximizing to do so.6 The empirical evidence on entry suggests, on the
other hand, that many entrepreneurs attempt entry in circumstances that would have led them to avoid
doing so if they were perfectly rational.7 As this article shows, however, the bounded rationality of real
entrepreneurs can account for the observed pattern of excess entry.8
Unlike the hypothetical, perfectly rational entrepreneur, real individuals are ‘‘boundedly
rational’’: they possess limited cognitive resources and their behavior is partly shaped by affect
and motivation.9 They sometimes engage in deliberate, formal judgment and decision making. But
more commonly, to survive and function well in a complex world, individuals instead use cog-
nitive and affective heuristics when making judgments under uncertainty and rely on situational
cues to guide their decisions. Although heuristic judgment and cue-dependent decision making are
generally adaptive and useful, they also lead people systematically and predictably to deviate from
strict rationality.10
The behavioral evidence on human judgment and decision making under uncertainty helps explain
otherwise perplexing patterns of excessively risky entry into manufacturing industries. In particular,
this evidence suggests that boundedly rational entrepreneurs may hold overoptimistic expectations
regarding the prospects of their ventures.11 With such expectations, even entrepreneurs possessing
rational risk preferences unwittingly may undertake excessively risky entry attempts.12 Moreover, the
aspirations of real entrepreneurs may lead them to manifest greater risk seeking (or at least lesser risk
5. Cf. William B. Gartner, ‘‘Who Is an Entrepreneur?’’ Is the Wrong Question, 12 AM. J. SMALL BUS. 11, at 26 (1988)
(stating that ‘‘[e]ntrepreneurship is the creation of organizations’’); see also William B. Gartner, What Are We Talking
About When We Talk About Entrepreneurship? 5 J. BUS. VENTURING 15 (1990) (using a survey and statistical analyses
to identify and categorize common usages of the term into those that focus on the characteristics of entrepreneurship
as a situation versus those that view a situation as entrepreneurial only if value was created). The focus on
manufacturing industries is due to their central role in the economy and the superior data available on these
compared to service industries.
APPLICATION, { 113 (CCH IntelliConnect, database updated Aug. 2015) (stating that ‘‘[a]s a general proposition business
firms are (or must be assumed to be) profit-maximizers’’); id. { 422a (stating, when discussing the likelihood of entry, that ‘‘
‘likely’ generally means ‘profitable,’ for entry will not occur in the absence of expected profits, after taking all costs and
risks into account’’) (emphasis added).
7. Avishalom Tor, The Fable of Entry: Bounded Rationality, Market Discipline, and Legal Policy, 101 MICH. L. REV. 482,
490–92 (2002).
8. The article draws extensively on the author’s previous work, most notably id.; Avishalom Tor, The Methodology of the
Behavioral Analysis of Law, 4 HAIFA L. REV. 237 (2008) [hereinafter Tor, Methodology]; and Avishalom Tor,
Understanding Behavioral Antitrust, 92 TEX. L. REV. 573 (2014) [hereinafter Tor, Behavioral Antitrust].
9. Tor, Methodology, supra note 8.
10. Christine Jolls, Cass R. Sunstein, & Richard Thaler, A Behavioral Approach to Law and Economics, 50 STAN. L. REV. 1471,
1477 (1998); Tor, Methodology, supra note 8, at 242–43.
11. See Colin Camerer & Dan Lovallo, Overconfidence and Excess Entry: An Experimental Approach, 89 AM. ECON. REV. 306
(1999); Giovanni Dosi & Dan Lovallo, Rational Entrepreneurs or Optimistic Martyrs? Some Considerations on
Technological Regimes, Corporate Entities, and the Evolutionary Role of Decision Biases, in TECHNOLOGICAL
INNOVATION: OVERSIGHTS AND FORESIGHTS 41 (Raghu Garud, Praveen Rattan Nayyar, & Zur Baruch Shapira eds., 1997).
12. In this article, the terms ‘‘overoptimism’’ and ‘‘overconfidence’’ are used interchangeably, following the common usage in
the behavioral economics and behavioral finance literatures as positively biased judgments. This usage should not be
confused with the much narrower usage of ‘‘overconfidence’’ in behavioral decision theory as the overestimation of the
accuracy of one’s judgments.

The Antitrust Bulletin 61(4)
aversion) than rationally warranted.13 By definition, such risk-seeking entrepreneurs willingly embark
upon ventures that their rational counterparts would have avoided for being too risky.
Recognition of the prevalence of excessively risky entry attempts—whether made by entrants who
harbor biased estimates of their prospects or by entrepreneurs who willingly take risks that rational
actors would have avoided—offers a new perspective on the competition among new entrants. Spe-
cifically, competitive pressures inevitably weed out the significant majority of these excessively risky
ventures. Yet at the same time, the probabilistic nature of entrepreneurial competition necessarily
culminates in the success ‘‘against the odds’’ of a small minority of the very large number of those
boundedly rational entrants. Hence, the resulting postentry landscape includes many ventures that
would never have been started if entrants were all rational. The presence of many excessively risky
ventures also diminishes other entrants’ likelihood of success, further deterring some rational entre-
preneurs from attempting entry.
At first blush, these seemingly harmful consequences may appear to justify policy interventions
aimed at curbing excessively risky entry, the better to align entrepreneurial competition with rational
action. Yet a closer look reveals that the regulation of excessively risky entry is mostly impractical and
generally undesirable. Moreover, despite its social costs, the excessive risk taking of many entrepre-
neurs also generates important social benefits, most notably by directly and indirectly facilitating
innovation and growth and providing an important source of long-term discipline for incumbent firms.
The revised understanding of the competition among boundedly rational and other entrepreneurs
that the behavioral analysis of entry offers also has important implications for antitrust law. For one,
the important benefits of excessively risky entry support antitrust law’s traditional hostility to regu-
latory or other artificial barriers to entry, if for reasons different from those commonly articulated. The
dynamics of competition...

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