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Courts of law and unforeseen contingencies

  • Luca Anderlini
  • Leonardo Felli
  • Andrew Postlewaite

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/
File Function: Open access version.
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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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  1. Louis Kaplow & Steven Shavell, 1999. "Economic Analysis of Law," NBER Working Papers 6960, National Bureau of Economic Research, Inc.
  2. Raghuram G. Rajan & Luigi Zingales, . "Power in a Theory of the Firm," CRSP working papers 335, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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  6. Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2003. "Should Courts Always Enforce What Contracting Parties Write?," PIER Working Paper Archive 06-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 01 Oct 2006.
  7. Oliver Hart & John Moore, 1988. "Property Rights and the Nature of the Firm," Working papers 495, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. B. Douglas Bernheim & Michael D. Whinston, 1997. "Incomplete Contracts and Strategic Ambiguity," Harvard Institute of Economic Research Working Papers 1787, Harvard - Institute of Economic Research.
  9. Nabil I. Al-Najjar & Luca Anderlini & Leonardo Felli, 2006. "Undescribable Events," Review of Economic Studies, Oxford University Press, vol. 73(4), pages 849-868.
  10. 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.
  11. Al-Najjar, Nabil I. & Anderlini, Luca & Felli, Leonardo, 2002. "Unforeseen Contingencies," CEPR Discussion Papers 3271, C.E.P.R. Discussion Papers.
  12. 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.
  13. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  14. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
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