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Verifiability and Contract Enforcement: A Model with Judicial Moral Hazard

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  • Murat Usman

Abstract

I model the litigation of a contract containing a variable not observable by courts, hence nonverifiable, unless the rational and self-interested judge exerts effort. He values the correct ruling but dislikes effort. Judicial effort is discretionary. I show that effort cost is inconsequential--"always breach" is equilibrium for any effort cost. But there exists another equilibrium where a small breach rate is achieved even with significant effort costs. Maximal remedies for breach are not optimal. Because effort is discretionary, low effort cost increases breach. Pretrial negotiations can have a substantial negative impact on verifiability under arbitrarily small deviations from full rationality. Copyright 2002, Oxford University Press.

Suggested Citation

  • Murat Usman, 2002. "Verifiability and Contract Enforcement: A Model with Judicial Moral Hazard," Journal of Law, Economics, and Organization, Oxford University Press, vol. 18(1), pages 67-94, April.
  • Handle: RePEc:oup:jleorg:v:18:y:2002:i:1:p:67-94
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    Cited by:

    1. Kirstein, Roland, 2005. "Bayesian Monitoring," CSLE Discussion Paper Series 2005-06, Saarland University, CSLE - Center for the Study of Law and Economics.
    2. Liu, Zhiyong & Avraham, Ronen, 2012. "Ex ante versus ex post expectation damages," International Review of Law and Economics, Elsevier, vol. 32(4), pages 339-355.
    3. Anderlini Luca & Felli Leonardo & Postlewaite Andrew, 2011. "Should Courts Always Enforce What Contracting Parties Write?," Review of Law & Economics, De Gruyter, vol. 7(1), pages 14-28, February.
    4. Koçkesen, Levent & Usman, Murat, 2012. "Litigation and settlement under judicial agency," International Review of Law and Economics, Elsevier, vol. 32(3), pages 300-308.
    5. Celik, Gorkem & Sayan, Serdar, 2005. "To Give In or Not To Give In To Bribery? Setting the Optimal Fines for Violations of Rules when the Enforcers are Likely to Ask for Bribes," Microeconomics.ca working papers celik-05-08-03-12-50-26, Vancouver School of Economics, revised 06 Aug 2008.
    6. Gorkem Celik & Serdar Sayan, 2008. "On the optimality of nonmaximal fines in the presence of corruptible law enforcers," Review of Economic Design, Springer;Society for Economic Design, vol. 12(3), pages 209-227, September.
    7. Anderlini, Luca & Postlewaite, Andrew & Felli, Leonardo, 2006. "Should courts always enforce what contracting parties write? this paper replaces TE/2003/464," LSE Research Online Documents on Economics 58189, London School of Economics and Political Science, LSE Library.
    8. Manuel Willington & Roy Costilla, 2007. "Endogenous Verifiability and Optimality in Agency: A non-contingent approach," ILADES-Georgetown University Working Papers inv189, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
    9. Chiara D'Alpaos & Michele Moretto & Paola Valbonesi & Sergio Vergalli, 2009. "It is never too late: Optimal penalty for investment delay in public procurement contracts," Working Papers 0907, University of Brescia, Department of Economics.
    10. Christmann Robin, 2015. "Tipping the Scales – Settlement, Appeal and the Relevance of Judicial Ambition," Review of Law & Economics, De Gruyter, vol. 11(2), pages 171-207, July.

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