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Courts and contractual innovation: a preliminary analysis

  • Mitchell Berlin
  • Yaron Leitner

The authors explore a model in which agents enter into a contract but are uncertain about how a judge will enforce it. The judge can consider a wide range of evidence, or instead, use a rule-based method of judgment that relies on limited information. The authors focus on the following tradeoff: Considering a wide range of evidence increases the likelihood of a correct ruling in the case at hand but undermines the formation of precedents that resolve legal uncertainty for subsequent agents. ; In a model of contractual innovation, they show that the use of evidence increases the likelihood of innovation in any period, while rule-driven judgments increase the rate of diffusion of the innovation. When courts can use a mixture of evidence and rules, the minimum amount of evidence that induces adoption is (weakly) decreasing over time. They also examine the breadth of precedents. Overlapping jurisdictions reduce the optimal breadth of precedents because broad precedents are more likely to introduce conflict. Accordingly, overlapping jurisdictions increase the value of using evidence. The authors use their model to interpret differences between the legal systems in the U.S. and England.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 05-27.

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Date of creation: 2005
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Handle: RePEc:fip:fedpwp:05-27
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  1. Anderlini, Luca & Felli, Leonardo & Postlewaite, Andrew, 2001. "Courts of Law and Unforeseen Contingencies," CEPR Discussion Papers 2835, C.E.P.R. Discussion Papers.
  2. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Legal Determinants of External Finance," Working Paper 19443, Harvard University OpenScholar.
  3. Luca Anderlini, Leonardo Felli, & Andrew Postlewaite, 2003. "Should Courts Always Enforce What Contracting Parties Write?," Working Papers gueconwpa~03-03-29, Georgetown University, Department of Economics.
  4. Ross Levine, 2005. "Law, Endowments, and Property Rights," NBER Working Papers 11502, National Bureau of Economic Research, Inc.
  5. Steven Shavell, 2003. "On the Writing and the Interpretation of Contracts," NBER Working Papers 10094, National Bureau of Economic Research, Inc.
  6. Kamma, Sreenivas & Weintrop, Joseph & Wier, Peggy, 1988. "Investors' perceptions of the Delaware Supreme Court decision in Unocal v. Mesa," Journal of Financial Economics, Elsevier, vol. 20(1-2), pages 419-430, January.
  7. Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer & Robert W. Vishny, 1996. "Law and Finance," NBER Working Papers 5661, National Bureau of Economic Research, Inc.
  8. Franks, Julian & Sussman, Oren, 2005. "Financial innovations and corporate bankruptcy," Journal of Financial Intermediation, Elsevier, vol. 14(3), pages 283-317, July.
  9. A. Mitchell Polinsky & Steven Shavell, 2005. "Economic Analysis of Law," Discussion Papers 05-005, Stanford Institute for Economic Policy Research.
  10. Nicola Gennaioli & Andrei Shleifer, 2005. "The Evolution of Precedent," NBER Working Papers 11265, National Bureau of Economic Research, Inc.
  11. Shurojit Chatterji & Dragan Filipovich, 2004. "Ambiguous Contracting: Natural Language and Judicial Interpretation," Econometric Society 2004 North American Winter Meetings 419, Econometric Society.
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