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Courts of Law and Unforeseen Contingencies

  • Luca Anderlini

    ()

    (Department of Economics, Georgetown University)

  • Leonardo Felli

    ()

    (Department of Economics, London School of Economics)

  • Andrew Postlewaite

    ()

    (Department of Economics, University of Pennsylvania)

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 against the unforeseen contingencies which the ex-ante contract cannot take into account. In this context, we are able to characterize fully the optimal decision rule for the court. The behavior of the optimal court is determined by the tradeoff 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://economics.sas.upenn.edu/system/files/working-papers/06-001.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 06-001.

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Length: 33 pages
Date of creation: 01 Mar 2001
Date of revision: 01 Jan 2006
Handle: RePEc:pen:papers:06-001
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  1. Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2003. "Should courts always enforce what contracting parties write?," LSE Research Online Documents on Economics 3593, London School of Economics and Political Science, LSE Library.
  2. Philippe Aghion & Jean Tirole, 1994. "Formal and Real Authority in Organizations," Working papers 95-8, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. repec:oup:restud:v:73:y:2006:i:4:p:849-868 is not listed on IDEAS
  4. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
  5. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
  6. 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.
  7. Nabil I. Al-Najjar & Luca Anderlini & Leonardo Felli, 2003. "Undescribable Events," CESifo Working Paper Series 1092, CESifo Group Munich.
  8. Alan Schwartz & Joel Watson, . "The Law and Economics of Costly Contracting," Yale Law School John M. Olin Center for Studies in Law, Economics, and Public Policy Working Paper Series yale_lepp-1004, Yale Law School John M. Olin Center for Studies in Law, Economics, and Public Policy.
  9. Raghuram G. Rajan & Luigi Zingales, 1997. "Power in a Theory of the Firm," NBER Working Papers 6274, National Bureau of Economic Research, Inc.
  10. Nabil Al-Najjar & Luca Anderlini & Leonardo Felli, 2002. "Unforeseen contingencies," LSE Research Online Documents on Economics 3578, London School of Economics and Political Science, LSE Library.
  11. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-58, December.
  12. Louis Kaplow & Steven Shavell, 1999. "Economic Analysis of Law," NBER Working Papers 6960, National Bureau of Economic Research, Inc.
  13. 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.
  14. Raghuram G. Rajan & Luigi Zingales, 1998. "Power in a Theory of the Firm," The Quarterly Journal of Economics, Oxford University Press, vol. 113(2), pages 387-432.
  15. 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.
  16. Ilya Segal, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 57-82.
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