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Should Courts Always Enforce What Contracting Parties Write?

Author

Listed:
  • Luca Anderlini

    (Department of Economics, Georgetown University)

  • Leonardo Felli

    (Department of Economics, London School of Economics)

  • Andrew Postlewaite

    (Department of Economics, University of Pennsylvania)

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, 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.
  • Handle: RePEc:pen:papers:06-024
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    Citations

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    Cited by:

    1. Madhav S. Aney, 2012. "Conflict with Quitting Rights: A Mechanism Design Approach," Working Papers 18-2012, Singapore Management University, School of Economics.
    2. 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.
    3. Luca Anderlini & Leonardo Felli & Andrew Postlewaite, 2013. "Active courts and menu contracts," Chapters, in: Thomas J. Miceli & Matthew J. Baker (ed.), Research Handbook on Economic Models of Law, chapter 13, pages 281-307, Edward Elgar Publishing.
    4. Leonardo Felli & Alessandro Riboni & Luca Anderlini, 2007. "Statute Law or Case Law?," 2007 Meeting Papers 952, Society for Economic Dynamics.
    5. 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.
    6. repec:dau:papers:123456789/7720 is not listed on IDEAS
    7. 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.
    8. Yaron Leitner, 2005. "Legal uncertainty and contractual innovation," Business Review, Federal Reserve Bank of Philadelphia, issue Q2, pages 26-32.
    9. 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.
    10. MacKenzie, Ian A. & Ohndorf, Markus, 2013. "Restricted Coasean bargaining," Journal of Public Economics, Elsevier, vol. 97(C), pages 296-307.
    11. Dana Heller & Ran Spiegler, 2008. "Contradiction as a form of Contractual Incompleteness," Economic Journal, Royal Economic Society, vol. 118(530), pages 875-888, July.
    12. Mitchell Berlin & Yaron Leitner, 2005. "Courts and contractual innovation: a preliminary analysis," Working Papers 05-27, Federal Reserve Bank of Philadelphia.
    13. 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.
    14. Francesco D'Acunto & Jin Xie & Jiaquan Yao, 2020. "Trust and Contracts: Empirical Evidence," CESifo Working Paper Series 8714, CESifo.
    15. Benjamin Bental & Bruno Deffains & Dominique Demougin, 2020. "Interpreting contracts: the purposive approach and non-comprehensive incentive contracts," European Journal of Law and Economics, Springer, vol. 50(2), pages 241-265, October.

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    More about this item

    Keywords

    Optimal Courts; Informational Externalities; Ex-Ante Welfare;
    All these keywords.

    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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