Should courts always enforce what contracting parties write?

Anderlini, Luca, Felli, Leonardo and Postlewaite, Andrew (2006) Should courts always enforce what contracting parties write? STICERD Discussion Papers (TE/06/510). Suntory and Toyota International Centres for Economics and Related Disciplines, London, UK.

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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 (Discussion Paper)
Official URL:	http://sticerd.lse.ac.uk
Additional Information:	© 2006 The Authors
Divisions:	Financial Markets Group Economics STICERD
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HD Industries. Land use. Labor
JEL classification:	K - Law and Economics > K4 - Legal Procedure, the Legal System, and Illegal Behavior > K40 - General C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C79 - Other D - Microeconomics > D7 - Analysis of Collective Decision-Making > D74 - Conflict; Conflict Resolution; Alliances L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L14 - Transactional Relationships; Contracts and Reputation; Networks D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D89 - Other
Date Deposited:	07 May 2008 10:07
Last Modified:	15 Sep 2023 23:06
URI:	http://eprints.lse.ac.uk/id/eprint/4677

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