Beyond Mistakes: The Next Wave of Behavioral Law and Economics

In this essay, which was presented as the Galway Lecture at Queen's University, Kingston, Ontario, I argue that law and economics has largely neglected a critical facet of human cognition: the process by which people make sense of the world. People make sense of the world by categorizing - by labeling, sorting and organizing their experiences to form their worldviews. Categorization has been extensively studied in the cognitive psychology literature. Law and economics gives short shrift to the process of categorization because it typically assumes that there is often a correct sense to be made: a fact of the matter agreed to be such by society. A car is a lemon or it is not; the car dealer is lying or she is not; a corporate officer conceals bad news about her company while she sells many of her shares or offers new shares to the public; the renter of a car treats the car badly because she's returning it the next day. Behavioral law and economics thus far hasn't helped matters; it also assumes that there is a fact of the matter. The jury asked to assess liability for an accident determines that because the accident happened, it is more likely than it actually was. Similarly, a person making a car purchase decision concludes Volvos are less safe than they really are because he heard about 3 crashes last week in which Volvos were involved. I discuss examples, from others' work and from mine, in which there isn't a clear societal consensus as to the fact of the matter, and understanding the process by which people categorize to form their beliefs can therefore be a helpful component of our analysis. The examples come from such disparate fields as racial discrimination, disclosure policy, and corporate governance, as well as norms and expressive law. Among the features of categorization that are particularly relevant are the following. Categories are constructed around prototypes (the car is the prototypical vehicle, perhaps): the prototype is the typical case, but there are many penumbral cases (a motorcycle sidecar?). We categorize as much or more to help us organize our lives as to get it right. (We have categories such as things I look for in a job, things I need to take on a trip or things politician X (or business associate Y or friend Z) is capable of. Apocryphally, the Inuits have far more categories for snow than people living in warmer climates have.) Categorizations can be finer or coarser grained, depending on our needs. All else equal, the more members of a particular race we know and encounter regularly, the more fine-grained our categorizations concerning members of that race are apt to be. Who has only one prototype of their own race? By contrast, a person might very well have only one prototype of a race whose members she very rarely encounters. How might this affect employers and employees? What belongs in a category, and what categories we have, is also not given. How does a corporate director decide what (types of) possible misbehavior of corporate officers to look for? How might we appraise what will be most effective at changing norms as to what is status-conferring: will people respond to something's being made more costly, or will the added costliness only add to the thing's status-conferring ability? What disclosures might make investment options easier to compare? (More basically, how do people assemble the choice sets from which they choose their investments?) The approach I've described differs profoundly from the bulk of the behavioral literature to date. Most of the behavioral literature discusses people who are reaching sub-optimal outcomes. The approach I'm discussing contemplates that we may or may not know whether the result is a mistake, and often, our best guess is that it is not a mistake. And the focus of the explanation is on the behavior at issue as a neutral fact about the world, not on its status as a mistake; consistent with the more traditional law and economics paradigm, people are doing the best they can to advance their own interests, albeit confronting rather different obstacles to doing so than they do in traditional law and economics analyses.