Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. St... more Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. Stochastic Courts 7. Menu Contracts 8. Conclusion Appendix Reference
In a Case Law regime Courts have more flexibility than in a Statute Law regime. Since Statutes ar... more In a Case Law regime Courts have more flexibility than in a Statute Law regime. Since Statutes are inevitably incomplete, this confers an advantage to the Case Law regime over the Statute Law one. However, all Courts rule ex-post, after most economic decisions are already taken. Therefore, the advantage of flexibility for Case Law is unavoidably paired with the potential for time-inconsistency. Under Case Law, Courts may be tempted to behave myopically and neglect ex-ante welfare because, ex-post, this may afford extra gains from trade for the parties currently in Court. The temptation to behave myopically is traded off against the effect of a Court's ruling, as a precedent, on the rulings of future Courts. When Case Law matures this temptation prevails and Case Law Courts succumb to the time-inconsistency problem. Statute Law, on the other hand pairs the lack of flexibility with the ability to commit in advance to a given (forward looking) rule. This solves the time-inconsistency problem afflicting the Case Law Courts. We conclude that when the nature of the legal environment is sufficiently heterogeneous and/or changes sufficiently often, the Case Law regime is superior: flexibility is the prevailing concern. By the same token, when the legal environment is sufficiently homogeneous and/or does not change very often, the Statute Law regime dominates: the ability to overcome the time-inconsistency problem is the dominant consideration.
... 45 See Hirshleifer, supra note 1, at 1545-1546. 46 See Peter Klibanoff et al., Investor React... more ... 45 See Hirshleifer, supra note 1, at 1545-1546. 46 See Peter Klibanoff et al., Investor Reaction to Salient News in Closed-end Country Funds, 53 J. Fin. 673 (1999). 47 SeeShaheen Pasha, Redemptions Aren't Lone Villain, Wall St. J., Aug. ...
Introduction 2. Related Literature 3. The Framework 4. Bertrand Competition 5. Workers' Investmen... more Introduction 2. Related Literature 3. The Framework 4. Bertrand Competition 5. Workers' Investments 6. Firms' Investments 7. The Inefficiency of Firms' Investments 8. Concluding Remarks Appendix References
Whistle-blowing is usually regarded as a way to identify abuse and wrongdoing on the part of gove... more Whistle-blowing is usually regarded as a way to identify abuse and wrongdoing on the part of governments and corporations. In this paper we show how, at a micro level, whistle-blowing can be used as a designer tool to prevent opportunistic behavior, that takes the form of collusion or blackmail, on the part of members of a simple hierarchical structure. We focus on a three-layered principal-supervisor-agent structure and show how the principal can use whistle-blowing as a way to prevent the supervisor and the agent from colluding to the detriment of the principal. To understand our mechanism we need to explicitly define the penalty a party has to incur for walking away from a collusive agreement. Rewarding whistle-blowing creates incentives for the uninformed colluding party to walk out of the side deal and report to the principal that collusion took place. This threat clearly reduces the informed party's incentive to participate in side deals. It also serves as a potential blackmail threat between the colluding parties. However, careful use of whistle-blowing allows the principal to eliminate opportunities for blackmail.
STICERD - Theoretical Economics Paper Series, 1993
This paper explores the extent to which the incompleteness of contracts can be attributed to thei... more This paper explores the extent to which the incompleteness of contracts can be attributed to their formal nature: the form, usually written, that contracts are required to take to be enforceable in a court of law by legal prescription, common practice, or simply the contracting parties' will. We model the formal nature of state-contingent contracts as the requirement that the mapping from states of the world to the corresponding outcomes must be of an algorithmic nature. It is shown that such algorithmic nature, although by itself is not enough to generate incomplete contracts, when paired with a similar restriction on the contracting parties' selection process yields endogenously incomplete optimal contracts.
We describe and analyze a contractual environment that allows a role for an active court. The mod... more We describe and analyze a contractual environment that allows a role for an active court. The model we analyze is the same as in Anderlini, Felli, and Postlewaite (2006). 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. In Anderlini, Felli, and Postlewaite (2006) the possibility of "menu contracts" between the informed buyer and the uninformed seller is described but not analyzed. Here, we fully analyze this case. We find that if we maintain the assumption that one of the potential objects of trade is not contractible ex-ante, the results of Anderlini, Felli, and Postlewaite (2006) survive intact. If however we let all "widgets" be contractible ex-ante, then multiple equilibria obtain. In this case the role for an active court is to ensure the inefficient pooling equilibria do not exist alongside the superior ones in which separation occurs.
Settling a legal dispute involves some costs that the parties have to incur ex-ante, for the pret... more Settling a legal dispute involves some costs that the parties have to incur ex-ante, for the pretrial negotiation and possible agreement to become feasible. Even in a full information world, if the distribution of these costs is sufficiently mismatched with the distribution of the parties' bargaining powers, a pretrial agreement may never be reached even though actual Court litigation is overall wasteful. Our results shed light on two key issues. First, a Plaintiff may initiate a lawsuit even though the parties fully anticipate that it will be settled out of Court. Second, the "likelihood" that a given lawsuit ends up in Court is unaffected by how trial costs are distributed among the litigants. The choice of fee-shifting rule can only affect whether the Plaintiff files a lawsuit in the first place. It does not affect whether it is settled before trial or litigated in Court.
We find an economic rationale for the common sense answer to the question in our title - courts s... more 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.
We study a contracting model with unforeseen contingencies in which the court is an active player... more 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 againt the unforeseen contingencies which the ex-ante contract cannot take into account. In this context, we are able to characterise fully the optimal decision rule for the court. The behaviour of the optimal court is determined by the trade-off between the need for incentives and the gains from insurance that voiding in some circumstances offers to the agents.
All Courts rule ex-post, after most economic decisions are sunk. This might generate a time-incon... more All Courts rule ex-post, after most economic decisions are sunk. This might generate a time-inconsistency problem. From an ex-ante perspective, Courts will have the (ex-post) temptation to be excessively lenient. This observation is at the root of the principle of stare decisis. Stare decisis forces Courts to weigh the benefits of leniency towards the current parties against the beneficial effects that tougher decisions have on future ones. We study these dynamics and find that stare decisis guarantees that precedents evolve towards ex-ante efficient decisions, thus alleviating the Courts' time-inconsistency problem. However, the dynamics do not converge to full efficiency.
We explore the determinants and effects of trust relationships between upstream suppliers and dow... more We explore the determinants and effects of trust relationships between upstream suppliers and downstream producers. Using unique survey data on individual supplier-buyer relationships in the German automotive industry, we show, by means of different measures of supplier-buyer trust, that higher levels of trust mitigate relationship-specific underinvestment in a classical holdup situation. Moreover, contrary to the extant literature, we show that higher levels of supplier's trust are reflected in the buyer's choice of a more competitive procurement strategy among potential suppliers.
We study a contracting model with unforeseen contingencies in which the court is an active player... more 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 againt the unforeseen contingencies which the ex-ante contract cannot take into account. In this context, we are able to characterise fully the optimal decision rule for the court. The behaviour of the optimal court is determined by the trade-off between the need for incentives and the gains from insurance that voiding in some circumstances offers to the agents.
This paper uses a new data set on child-adoption matching to estimate the preferences of potentia... more This paper uses a new data set on child-adoption matching to estimate the preferences of potential adoptive parents over U.S.born and unborn children relinquished for adoption. We identify significant preferences favoring girls and against African-American children put up for adoption. These attitudes vary in magnitudes across different adoptive parents-heterosexual, same-sex couples, and single women. We consider the effects of excluding single women and same-sex couples from the process, and find that this would substantially reduce the overall number of adopted children. Adoption is an important phenomenon in the U.S. According to the Census 2000, about 1.6 million or 2.5% of all children were adopted. Of these, 87% were U.S.-born and adopted through the domestic-adoption channel. In terms of revenues, the adoption industry is a substantial one, generating approximately 2-3 billion dollars annually (see Riben, 2007). In most cases, a successful domestic adoption is the result of a match between a birth mother (BMO hereafter) who seeks to relinquish her child, and prospective adoptive parents (PAPs hereafter). The underlying matching process is fairly decentralized and involves a bilateral search characterized by several layers of mediation: Typically, adoption agencies represent BMOs, while PAPs work visa-vis adoption agencies, lawyers, or facilitators. According to the Census, 54% of U.S.-born adopted children under the age of 10 are female, and 18% are African-American. In contrast, girls and African-Americans represent 48% and 15% of all children, respectively. 1 These differences can be explained by either the preferences of PAPs (the demand side), or the
Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. St... more Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. Stochastic Courts 7. Menu Contracts 8. Conclusion Appendix Reference
This paper explores the extent to which the incompleteness of contracts can be attributed to thei... more This paper explores the extent to which the incompleteness of contracts can be attributed to their formal nature: the form, usually written, that contracts are required to take to be enforceable in a court of law by legal prescription, common practice, or simply the contracting parties' will. We model the formal nature of state-contingent contracts as the requirement that the
Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. St... more Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. Stochastic Courts 7. Menu Contracts 8. Conclusion Appendix Reference
In a Case Law regime Courts have more flexibility than in a Statute Law regime. Since Statutes ar... more In a Case Law regime Courts have more flexibility than in a Statute Law regime. Since Statutes are inevitably incomplete, this confers an advantage to the Case Law regime over the Statute Law one. However, all Courts rule ex-post, after most economic decisions are already taken. Therefore, the advantage of flexibility for Case Law is unavoidably paired with the potential for time-inconsistency. Under Case Law, Courts may be tempted to behave myopically and neglect ex-ante welfare because, ex-post, this may afford extra gains from trade for the parties currently in Court. The temptation to behave myopically is traded off against the effect of a Court's ruling, as a precedent, on the rulings of future Courts. When Case Law matures this temptation prevails and Case Law Courts succumb to the time-inconsistency problem. Statute Law, on the other hand pairs the lack of flexibility with the ability to commit in advance to a given (forward looking) rule. This solves the time-inconsistency problem afflicting the Case Law Courts. We conclude that when the nature of the legal environment is sufficiently heterogeneous and/or changes sufficiently often, the Case Law regime is superior: flexibility is the prevailing concern. By the same token, when the legal environment is sufficiently homogeneous and/or does not change very often, the Statute Law regime dominates: the ability to overcome the time-inconsistency problem is the dominant consideration.
... 45 See Hirshleifer, supra note 1, at 1545-1546. 46 See Peter Klibanoff et al., Investor React... more ... 45 See Hirshleifer, supra note 1, at 1545-1546. 46 See Peter Klibanoff et al., Investor Reaction to Salient News in Closed-end Country Funds, 53 J. Fin. 673 (1999). 47 SeeShaheen Pasha, Redemptions Aren't Lone Villain, Wall St. J., Aug. ...
Introduction 2. Related Literature 3. The Framework 4. Bertrand Competition 5. Workers' Investmen... more Introduction 2. Related Literature 3. The Framework 4. Bertrand Competition 5. Workers' Investments 6. Firms' Investments 7. The Inefficiency of Firms' Investments 8. Concluding Remarks Appendix References
Whistle-blowing is usually regarded as a way to identify abuse and wrongdoing on the part of gove... more Whistle-blowing is usually regarded as a way to identify abuse and wrongdoing on the part of governments and corporations. In this paper we show how, at a micro level, whistle-blowing can be used as a designer tool to prevent opportunistic behavior, that takes the form of collusion or blackmail, on the part of members of a simple hierarchical structure. We focus on a three-layered principal-supervisor-agent structure and show how the principal can use whistle-blowing as a way to prevent the supervisor and the agent from colluding to the detriment of the principal. To understand our mechanism we need to explicitly define the penalty a party has to incur for walking away from a collusive agreement. Rewarding whistle-blowing creates incentives for the uninformed colluding party to walk out of the side deal and report to the principal that collusion took place. This threat clearly reduces the informed party's incentive to participate in side deals. It also serves as a potential blackmail threat between the colluding parties. However, careful use of whistle-blowing allows the principal to eliminate opportunities for blackmail.
STICERD - Theoretical Economics Paper Series, 1993
This paper explores the extent to which the incompleteness of contracts can be attributed to thei... more This paper explores the extent to which the incompleteness of contracts can be attributed to their formal nature: the form, usually written, that contracts are required to take to be enforceable in a court of law by legal prescription, common practice, or simply the contracting parties' will. We model the formal nature of state-contingent contracts as the requirement that the mapping from states of the world to the corresponding outcomes must be of an algorithmic nature. It is shown that such algorithmic nature, although by itself is not enough to generate incomplete contracts, when paired with a similar restriction on the contracting parties' selection process yields endogenously incomplete optimal contracts.
We describe and analyze a contractual environment that allows a role for an active court. The mod... more We describe and analyze a contractual environment that allows a role for an active court. The model we analyze is the same as in Anderlini, Felli, and Postlewaite (2006). 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. In Anderlini, Felli, and Postlewaite (2006) the possibility of "menu contracts" between the informed buyer and the uninformed seller is described but not analyzed. Here, we fully analyze this case. We find that if we maintain the assumption that one of the potential objects of trade is not contractible ex-ante, the results of Anderlini, Felli, and Postlewaite (2006) survive intact. If however we let all "widgets" be contractible ex-ante, then multiple equilibria obtain. In this case the role for an active court is to ensure the inefficient pooling equilibria do not exist alongside the superior ones in which separation occurs.
Settling a legal dispute involves some costs that the parties have to incur ex-ante, for the pret... more Settling a legal dispute involves some costs that the parties have to incur ex-ante, for the pretrial negotiation and possible agreement to become feasible. Even in a full information world, if the distribution of these costs is sufficiently mismatched with the distribution of the parties' bargaining powers, a pretrial agreement may never be reached even though actual Court litigation is overall wasteful. Our results shed light on two key issues. First, a Plaintiff may initiate a lawsuit even though the parties fully anticipate that it will be settled out of Court. Second, the "likelihood" that a given lawsuit ends up in Court is unaffected by how trial costs are distributed among the litigants. The choice of fee-shifting rule can only affect whether the Plaintiff files a lawsuit in the first place. It does not affect whether it is settled before trial or litigated in Court.
We find an economic rationale for the common sense answer to the question in our title - courts s... more 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.
We study a contracting model with unforeseen contingencies in which the court is an active player... more 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 againt the unforeseen contingencies which the ex-ante contract cannot take into account. In this context, we are able to characterise fully the optimal decision rule for the court. The behaviour of the optimal court is determined by the trade-off between the need for incentives and the gains from insurance that voiding in some circumstances offers to the agents.
All Courts rule ex-post, after most economic decisions are sunk. This might generate a time-incon... more All Courts rule ex-post, after most economic decisions are sunk. This might generate a time-inconsistency problem. From an ex-ante perspective, Courts will have the (ex-post) temptation to be excessively lenient. This observation is at the root of the principle of stare decisis. Stare decisis forces Courts to weigh the benefits of leniency towards the current parties against the beneficial effects that tougher decisions have on future ones. We study these dynamics and find that stare decisis guarantees that precedents evolve towards ex-ante efficient decisions, thus alleviating the Courts' time-inconsistency problem. However, the dynamics do not converge to full efficiency.
We explore the determinants and effects of trust relationships between upstream suppliers and dow... more We explore the determinants and effects of trust relationships between upstream suppliers and downstream producers. Using unique survey data on individual supplier-buyer relationships in the German automotive industry, we show, by means of different measures of supplier-buyer trust, that higher levels of trust mitigate relationship-specific underinvestment in a classical holdup situation. Moreover, contrary to the extant literature, we show that higher levels of supplier's trust are reflected in the buyer's choice of a more competitive procurement strategy among potential suppliers.
We study a contracting model with unforeseen contingencies in which the court is an active player... more 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 againt the unforeseen contingencies which the ex-ante contract cannot take into account. In this context, we are able to characterise fully the optimal decision rule for the court. The behaviour of the optimal court is determined by the trade-off between the need for incentives and the gains from insurance that voiding in some circumstances offers to the agents.
This paper uses a new data set on child-adoption matching to estimate the preferences of potentia... more This paper uses a new data set on child-adoption matching to estimate the preferences of potential adoptive parents over U.S.born and unborn children relinquished for adoption. We identify significant preferences favoring girls and against African-American children put up for adoption. These attitudes vary in magnitudes across different adoptive parents-heterosexual, same-sex couples, and single women. We consider the effects of excluding single women and same-sex couples from the process, and find that this would substantially reduce the overall number of adopted children. Adoption is an important phenomenon in the U.S. According to the Census 2000, about 1.6 million or 2.5% of all children were adopted. Of these, 87% were U.S.-born and adopted through the domestic-adoption channel. In terms of revenues, the adoption industry is a substantial one, generating approximately 2-3 billion dollars annually (see Riben, 2007). In most cases, a successful domestic adoption is the result of a match between a birth mother (BMO hereafter) who seeks to relinquish her child, and prospective adoptive parents (PAPs hereafter). The underlying matching process is fairly decentralized and involves a bilateral search characterized by several layers of mediation: Typically, adoption agencies represent BMOs, while PAPs work visa-vis adoption agencies, lawyers, or facilitators. According to the Census, 54% of U.S.-born adopted children under the age of 10 are female, and 18% are African-American. In contrast, girls and African-Americans represent 48% and 15% of all children, respectively. 1 These differences can be explained by either the preferences of PAPs (the demand side), or the
Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. St... more Introduction 2. Example 3. The Model 4. Passive Court Equilibria 5. Active Court Equilibria 6. Stochastic Courts 7. Menu Contracts 8. Conclusion Appendix Reference
This paper explores the extent to which the incompleteness of contracts can be attributed to thei... more This paper explores the extent to which the incompleteness of contracts can be attributed to their formal nature: the form, usually written, that contracts are required to take to be enforceable in a court of law by legal prescription, common practice, or simply the contracting parties' will. We model the formal nature of state-contingent contracts as the requirement that the
This paper investigates the market provision of firm-specific training , and identifies the ineff... more This paper investigates the market provision of firm-specific training , and identifies the inefficiencies associated with it. Within a general stochastic learning-by-doing model, we show that market provision of firm-specific training is inefficient. In order to understand the nature of this inefficiency better, we analyze two special cases of the model: the productivity-enhancement model and the accelerated-learning model. In both models, the inefficiency is necessarily present. However, the nature of the inefficiency depends on the balance between the two key components of training, namely productivity enhancement and employee evaluation. In the productivity-enhancement model, training results in an increase in productivity enhancement but no change in employee evaluation, and training is overprovided by the market. In the accelerated learning model, training results in a proportionate increase in productivity enhancement and employee evaluation, and training is underprovided by the market. In both cases, turnover is inefficiently low. * We are grateful to Steve Nickell for encouraging us to think about training, and to the editors of the journal, Alessandro Pavan and Xavier Vives, an associate editor and an anonymous referee for their insightful comments. We thank Heski Bar-Isaac, Chris Pissarides, Steve Pischke, Yona Rubinstein and Yoram Weiss for very useful discussions and Malte Loos for research assistance. Leonardo Felli would like to thank the Department of Economics of the Stern School of Business at NYU for their generous hospitality. Christopher Harris would like to thank the British Academy for their generous support, and the Institute for Advanced Studies, Princeton for their generous hospitality.
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