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Should courts always enforce what contracting parties write? this paper replaces TE/2003/464

Author

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  • Anderlini, Luca
  • Postlewaite, Andrew
  • Felli, Leonardo

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

  • 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.
  • Handle: RePEc:ehl:lserod:58189
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    File URL: http://eprints.lse.ac.uk/58189/
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    References listed on IDEAS

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    1. Fudenberg, Drew & Tirole, Jean, 1991. "Perfect Bayesian equilibrium and sequential equilibrium," Journal of Economic Theory, Elsevier, vol. 53(2), pages 236-260, April.
    2. Bebchuk, Lucian Ayre & Shavell, Steven, 1991. "Information and the Scope of Liability for Breach of Contract: The Rule of Hadley vs. Baxendale," Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(2), pages 284-312, Fall.
    3. Steven Shavell, 2006. "On the Writing and the Interpretation of Contracts," Journal of Law, Economics, and Organization, Oxford University Press, vol. 22(2), pages 289-314, October.
    4. Maskin, Eric & Tirole, Jean, 1990. "The Principal-Agent Relationship with an Informed Principal: The Case of Private Values," Econometrica, Econometric Society, vol. 58(2), pages 379-409, March.
    5. 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.
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    Citations

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    Cited by:

    1. 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.
    2. Leonardo Felli & Alessandro Riboni & Luca Anderlini, 2007. "Statute Law or Case Law?," 2007 Meeting Papers 952, Society for Economic Dynamics.

    More about this item

    Keywords

    optimal courts; informational externalities; ex-ante welfare;

    JEL classification:

    • J1 - Labor and Demographic Economics - - Demographic Economics
    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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