Working Paper: CEPR ID: DP4197
Authors: Luca Anderlini; Leonardo Felli; Andrew Postlewaite
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 analyse 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.
Keywords: Informational externalities; Optimal courts; Ex ante welfare
JEL Codes: C79; D74; D89; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| court actions (K41) | welfare outcomes of contracting parties (D69) |
| court intervenes (K40) | induces parties to disclose private information (D82) |
| voiding contracts (D86) | encourages parties to separate based on their information types (L15) |
| optimal court rule (K41) | net welfare gain (D69) |