Should Courts Always Enforce What Contracting Parties Write?

16 Pages Posted: 26 Jan 2009

See all articles by Luca Anderlini

Luca Anderlini

Georgetown University - Department of Economics

Leonardo Felli

University of Cambridge, Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Andrew Postlewaite

University of Pennsylvania - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: January 23, 2009

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 model with risk-neutral agents and asymmetric information. 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, inefficient pooling obtains in equilibrium. By voiding some contracts the court is able to induce them to separate, and hence improve ex-ante welfare.

Keywords: Optimal Courts, Informational Externalities, Ex-Ante Welfare

JEL Classification: C79, D74, D89, K40, L14

Suggested Citation

Anderlini, Luca and Felli, Leonardo and Postlewaite, Andrew, Should Courts Always Enforce What Contracting Parties Write? (January 23, 2009). PIER Working Paper No. 09-004, Available at SSRN: https://ssrn.com/abstract=1332116 or http://dx.doi.org/10.2139/ssrn.1332116

Luca Anderlini

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-6361 (Phone)
202-687-6102 (Fax)

HOME PAGE: http://www.georgetown.edu/faculty/la2/

Leonardo Felli (Contact Author)

University of Cambridge, Faculty of Economics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
+44 1223 335221 (Phone)

HOME PAGE: http://www.felli.info

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Andrew Postlewaite

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-7350 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~apostlew

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