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Should Courts always Enforce what Contracting Parties Write?

Author

Listed:
  • Luca Anderlini
  • Leonardo Felli
  • Andrew Postlewaite

Abstract

We find an economic rationale for the common sense answer to the question in our title — courts should not always enforce what the contracting parties write. We describe and analyze a contractual environment that allows a role for an active court. An active court can improve on the outcome that the parties would achieve without it. The institutional role of the court is to maximize the parties’ welfare under a veil of ignorance. We study a buyer-seller multiple-widget model with risk-neutral agents, asymmetric information and ex-ante investments. The court must decide when to uphold a contract and when to void it. The parties know their private information at the time of contracting, and this drives a wedge between ex-ante and interim-efficient contracts. In particular, if the court enforces all contracts, pooling obtains in equilibrium. By voiding some contracts the court is able to induce them to separate, and hence improve ex-ante welfare. In some cases, an ambiguous court that voids and upholds both with positive probability may be able to increase welfare even further.

Suggested Citation

  • Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2006. "Should Courts always Enforce what Contracting Parties Write?," CESifo Working Paper Series 1847, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_1847
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Luca Anderlini & Leonardo Felli & Alessandro Riboni, 2014. "Why Stare Decisis?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(4), pages 726-738, October.
    2. Leonardo Felli & Alessandro Riboni & Luca Anderlini, 2007. "Statute Law or Case Law?," 2007 Meeting Papers 952, Society for Economic Dynamics.
    3. Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2013. "Active courts and menu contracts," Chapters,in: Research Handbook on Economic Models of Law, chapter 13, pages 281-307 Edward Elgar Publishing.
    4. Andrew Postlewaite, 2007. "Courts of Law and Unforeseen Contingencies," Journal of Law, Economics, and Organization, Oxford University Press, vol. 23(3), pages 662-684, October.
    5. 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.
    6. MacKenzie, Ian A. & Ohndorf, Markus, 2013. "Restricted Coasean bargaining," Journal of Public Economics, Elsevier, pages 296-307.
    7. Madhav S. Aney, 2012. "Conflict with Quitting Rights: A Mechanism Design Approach," Working Papers 18-2012, Singapore Management University, School of Economics.
    8. Dana Heller & Ran Spiegler, 2008. "Contradiction as a form of Contractual Incompleteness," Economic Journal, Royal Economic Society, vol. 118(530), pages 875-888, July.
    9. Yaron Leitner, 2005. "Legal uncertainty and contractual innovation," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 26-32.
    10. Fares, M’hand, 2005. "Quels fondements à l’incomplétude des contrats?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 81(3), pages 535-555, Septembre.
    11. Giovanni Maggi & Robert W. Staiger, 2008. "On the Role and Design of Dispute Settlement Procedures in International Trade Agreements," NBER Working Papers 14067, National Bureau of Economic Research, Inc.
    12. Mitchell Berlin & Yaron Leitner, 2005. "Courts and contractual innovation: a preliminary analysis," Working Papers 05-27, Federal Reserve Bank of Philadelphia, revised 01 Dec 2005.
    13. repec:dau:papers:123456789/7720 is not listed on IDEAS

    More about this item

    Keywords

    optimal courts; informational externalities; ex-ante welfare;

    JEL classification:

    • C79 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Other
    • D74 - Microeconomics - - Analysis of Collective Decision-Making - - - Conflict; Conflict Resolution; Alliances; Revolutions
    • D89 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Other
    • K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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