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Courts of law and unforeseen contingencies

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  • Luca Anderlini
  • Leonardo Felli
  • Andrew Postlewaite

Abstract

We study a contracting model with unforeseen contingencies in which the court is an active player. Ex-ante, the contracting parties cannot include the risky unforeseen contingencies in the contract they draw up. Ex-post the court observes whether an unforeseen contingency occurred, and decides whether to void or uphold the contract. If the contract is voided by the court, the parties can renegotiate a new agreement ex-post. There are two effects of a court that voids more contracts. The parties' incentives to undertake relationship-specific investment are reduced, while the parties enjoy greater insurance againt the unforeseen contingencies which the ex-ante contract cannot take into account. In this context, we are able to characterise fully the optimal decision rule for the court. The behaviour of the optimal court is determined by the trade-off between the need for incentives and the gains from insurance that voiding in some circumstances offers to the agents.

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File URL: http://eprints.lse.ac.uk/3576/
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 3576.

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Length: 34 pages
Date of creation: Feb 2003
Date of revision:
Handle: RePEc:ehl:lserod:3576

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Keywords: Courts of law; unforeseen contingencies; precedents; incentives; insurance.;

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References

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  1. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(6), pages 1119-58, December.
  2. Anderlini Luca & Felli Leonardo & Postlewaite Andrew, 2011. "Should Courts Always Enforce What Contracting Parties Write?," Review of Law & Economics, De Gruyter, De Gruyter, vol. 7(1), pages 14-28, February.
  3. Bernheim, B Douglas & Whinston, Michael D, 1998. "Incomplete Contracts and Strategic Ambiguity," American Economic Review, American Economic Association, vol. 88(4), pages 902-32, September.
  4. Raghuram G. Rajan & Luigi Zingales, 1998. "Power In A Theory Of The Firm," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 113(2), pages 387-432, May.
  5. Aghion, Philippe & Tirole, Jean, 1994. "Formal and Real Authority in Organizations," IDEI Working Papers 37, Institut d'Économie Industrielle (IDEI), Toulouse.
  6. Louis Kaplow & Steven Shavell, 1999. "Economic Analysis of Law," NBER Working Papers 6960, National Bureau of Economic Research, Inc.
  7. Nabil J Al-Najjar & Luca Anderlini & Leonardo Felli, 2002. "Unforeseen Contingencies," STICERD - Theoretical Economics Paper Series, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE 431, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  8. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, Econometric Society, vol. 67(4), pages 741-782, July.
  10. Alan Schwartz, 2004. "The Law and Economics of Costly Contracting," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 20(1), pages 2-31, April.
  11. Schwartz, Alan & Watson, Joel, 2001. "The Law and Economics of Costly Contracting," University of California at San Diego, Economics Working Paper Series qt2wh8m7bv, Department of Economics, UC San Diego.
  12. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  13. Nabil I. Al-Najjar & Luca Anderlini & Leonardo Felli, 2003. "Undescribable Events," CESifo Working Paper Series 1092, CESifo Group Munich.
  14. Dekel, Eddie & Lipman, Barton L. & Rustichini, Aldo, 1998. "Recent developments in modeling unforeseen contingencies," European Economic Review, Elsevier, vol. 42(3-5), pages 523-542, May.
  15. Schwartz, Alan & Watson, Joel, 2000. "Economic and Legal Aspects of Costly Recontracting," University of California at San Diego, Economics Working Paper Series qt4jr3g3h7, Department of Economics, UC San Diego.
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