Should Courts Always Enforce What Contracting Parties Write?

50 Pages Posted: 11 Nov 2003

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: November 2006

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 asymmetric information and ex-ante investments, in which some contingencies cannot be contracted on. 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, some types pool in equilibrium. By voiding some contracts that the pooling types would like the court to enforce, the court is able to induce them to separate, and hence to 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.

Note: An updated version of this abstract can be found at: http://ssrn.com/abstract=939002

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? (November 2006). CESifo Working Paper No. 1847, PIER Working Paper No. 03-026, U of Penn, Inst for Law & Econ Research Paper No. 03-30, Available at SSRN: https://ssrn.com/abstract=466442 or http://dx.doi.org/10.2139/ssrn.466442

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

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 (Contact Author)

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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