Good Law & Economics needs suitable microeconomic models: the case against the application of standard agency models to the professions
AbstractNotwithstanding its widespread acceptance in the law & economics literature, agency theory could not be in general the most suitable microeconomic modeling for designing efficient and fair economic transactions institutions. The case against the standard principal-agent modeling is made about liberalizations of professional services that introduced schemes of professionals’ remuneration contingent on outcomes – i.e. “contingent fees” for lawyers. If the relationship between the professional and clients is seen according to the principal-agent model, contingency fees can be economically justified as an efficient incentive for the professional’s effort. The case is quite different, however, if the situation is seen as one of bounded rationality and unforeseen and asymmetrically gathered events. Remunerations contingent on outcomes in these contexts can generate pathological incentives. This paper argues that the professional relationship is an authority relationship based of contractual incompleteness, which requires the reliance on trustworthiness of the authority position’s holder. Hence I propose a model for understanding the professional relationship which extends the “formal vs. real authority” model proposed a few years ago by Aghion and Tirole (1997). This leads to underline the essential role played by behavioral hypothesis on professionals’ “endogenous” adherence to ethical standards that prevent conflict of interests and induce the professional’s identification with her clients’ interests, based on reciprocity and conformist preferences. A game theoretical thought experiment aimed at checking the case for or against using agency models in modeling the professional relationship is then carried out. It shows that (i) in the case of a self-interested lawyer, notwithstanding that utilitarian efficiency is safeguarded, contingent fees leads to not respecting the fiduciary obligations with at least one client (to detriment of Pareto optimality and impartial and loyal treatment of all clients) for only the ex post mostly remunerative cases are litigated. (ii) In the case of the lawyer’s willingness to comply with deontology standards - requiring impartial protection of all the clients’ rights, under a condition of minimal individual rationality - contingent fees lead nevertheless to neutralization of the deontological motivation and to a loss of efficiency in utilitarian sense. A Pareto optimal, impartial, as well as efficient, arrangement aimed at maximizing the total volume of damage compensation is then considered. Nevertheless the main result is that under a contingent fee contract, even if these motivations were available, the professional could not carry out them because the logic of the contract doesn’t allow pooling different cases’ damage compensations in order of carrying out redress across the lucky and unlucky clients.
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Bibliographic InfoPaper provided by Department of Economics, University of Trento, Italia in its series Department of Economics Working Papers with number 0608.
Date of creation: 2006
Date of revision:
lawyers’ contingent fees; principal-agent; incomplete contracts; authority; professional ethics; fiduciary duties; reciprocity; conformist preferences.;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-02-24 (All new papers)
- NEP-CBE-2007-02-24 (Cognitive & Behavioural Economics)
- NEP-LAW-2007-02-24 (Law & Economics)
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