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Courts and contractual innovation: a preliminary analysis

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  • Mitchell Berlin
  • Yaron Leitner

Abstract

The authors explore a model in which agents enter into a contract but are uncertain about how a judge will enforce it. The judge can consider a wide range of evidence, or instead, use a rule-based method of judgment that relies on limited information. The authors focus on the following tradeoff: Considering a wide range of evidence increases the likelihood of a correct ruling in the case at hand but undermines the formation of precedents that resolve legal uncertainty for subsequent agents. ; In a model of contractual innovation, they show that the use of evidence increases the likelihood of innovation in any period, while rule-driven judgments increase the rate of diffusion of the innovation. When courts can use a mixture of evidence and rules, the minimum amount of evidence that induces adoption is (weakly) decreasing over time. They also examine the breadth of precedents. Overlapping jurisdictions reduce the optimal breadth of precedents because broad precedents are more likely to introduce conflict. Accordingly, overlapping jurisdictions increase the value of using evidence. The authors use their model to interpret differences between the legal systems in the U.S. and England.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 05-27.

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Date of creation: 2005
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Handle: RePEc:fip:fedpwp:05-27

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Keywords: Contracts;

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References

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  1. 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.
  2. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Law and Finance," Working Paper 19451, Harvard University OpenScholar.
  3. Kamma, Sreenivas & Weintrop, Joseph & Wier, Peggy, 1988. "Investors' perceptions of the Delaware Supreme Court decision in Unocal v. Mesa," Journal of Financial Economics, Elsevier, Elsevier, vol. 20(1-2), pages 419-430, January.
  4. Shurojit Chatterji & Dragan Filipovich, 2004. "Ambiguous Contracting: Natural Language and Judicial Interpretation," Econometric Society 2004 North American Winter Meetings, Econometric Society 419, Econometric Society.
  5. Ross Levine, 2005. "Law, Endowments, and Property Rights," NBER Working Papers 11502, National Bureau of Economic Research, Inc.
  6. Nicola Gennaioli & Andrei Shleifer, 2005. "The Evolution of Precedent," NBER Working Papers 11265, National Bureau of Economic Research, Inc.
  7. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Legal Determinants of External Finance," Working Paper 19443, Harvard University OpenScholar.
  8. Steven Shavell, 2003. "On the Writing and the Interpretation of Contracts," NBER Working Papers 10094, National Bureau of Economic Research, Inc.
  9. Anderlini, Luca & Felli, Leonardo & Postlewaite, Andrew, 2001. "Courts of Law and Unforeseen Contingencies," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2835, C.E.P.R. Discussion Papers.
  10. Franks, Julian & Sussman, Oren, 2005. "Financial innovations and corporate bankruptcy," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 14(3), pages 283-317, July.
  11. A. Mitchell Polinsky & Steven Shavell, 2005. "Economic Analysis of Law," Discussion Papers, Stanford Institute for Economic Policy Research 05-005, Stanford Institute for Economic Policy Research.
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