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

Anderlini, Luca and Postlewaite, Andrew and Felli, Leonardo (2006) Should courts always enforce what contracting parties write? this paper replaces TE/2003/464. Theoretical Economics, TE/2006/510. The London School of Economics and Political Science, Suntory and Toyota International Centres for Economics and Related Disciplines, London, UK.

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Identification Number: TE/2006/510

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.

Item Type: Monograph (Report)
Official URL: http://sticerd.lse.ac.uk/
Additional Information: © 2006 The Authors
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Sets: Departments > Economics
Research centres and groups > Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD)
Research centres and groups > Financial Markets Group (FMG)
Date Deposited: 23 Jul 2014 15:59
Last Modified: 24 Jul 2014 07:58
Funders: National Science Foundation
URI: http://eprints.lse.ac.uk/id/eprint/58189

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