Kathryn E. Spier

Incomplete Contracts and Signalling

This article presents a principal-agent model in which asymmetric information leads to contractual incompleteness. I show that in the presence of transactions costs, incompleteness may act as a signal of the principals type. Two types of transactions costs are considered: those incurred ex ante (drafting costs) and those incurred ex post (enforcement or verification costs). I prove that in the presence of either of these costs asymmetric information leads to more contractual incompleteness than full information does.

On the Efficiency of Privately Stipulated Damages for Breach of Contract: Entry Barriers, Reliance, and Renegotiation

Two roles for stipulated damage provisions have been debated in the literature: protecting relationship-specific investments and inefficiently excluding competitors. Aghion and Bolton (1987) formally demonstrate the latter effect in a model without investment or renegotiation. Although introducing renegotiation alone destroys their result, introducing both renegotiation and investment restores it. In particular, if an entrant has market power and the sellers cost of production is observable but not verifiable, then privately stipulated damages are set at a socially excessive level to facilitate the extraction of the entrants surplus. In contrast, if the entrant prices competitively (as typically is assumed in the law and economics literature on breach), then private stipulation is efficient. Whereas a simple legal restriction on the contract corrects for any inefficiency, standard court-imposed remedies do not.

Designing a private industry: Government auctions with endogenous market structure

Abstract This paper considers government mechanisms for auctioning production rights in which both the winners and the market structure, doupoly (dual-sourcing), monopoly (sole-sourcing), or government-owned production, are a function of the bids. In designing the optimal mechanism, the government considers the tradeoffs among consumer surplus, producer surplus, and revenue. Under incomplete information, doupoly is implemented less frequently, and government production more frequently, than under complete information. When bidders are symmetric, the optimal mechanism can be implemented as a modified second-price auction. Applications to privatization, deregulation, and defense procurement are discussed.

Burdens of Proof in Civil Litigation: An Economic Perspective

Burden of proof rules, which require a specified party to produce evidence on a contested issue, are central to the adversary system. In this article, we model burden of proof rules as a device for minimizing the costs of litigation. The central point to emerge from the model is that, properly assigned, a burden of proof rule economizes on the transmission of information to the court. We use the model to explain characteristic practices of courts in assigning the burden of proof.

Trigger Happy or Gun Shy? Dissolving Common-Value Partnerships with Texas Shootouts

The operating agreements of many business ventures include clauses to facilitate the exit of joint owners. In so-called Texas Shootouts, one owner names a single buy-sell price and the other owner is compelled to either buy or sell shares at that named price. Despite their prevalence in real-world contracts, Texas Shootouts are rarely triggered. In our theoretical framework, sole ownership is more efficient than joint ownership. Negotiations are frustrated, however, by the presence of asymmetric information. In equilibrium, owners eschew buy-sell offers in favor of simple offers to buy or to sell shares and bargaining failures arise. Experimental data support these findings.

A Note on the Divergence between the Private and the Social Motive to Settle under a Negligence Rule

The private motives to settle civil lawsuits are seldom aligned with the interests of society. This article presents a simple model of a negligence rule where there is too much settlement. During pretrial bargaining, the injurer has private information about his care level. In equilibrium the injurer randomizes between taking due care and being negligent, and the uninformed victim randomizes between making a high settlement offer (playing tough) and making a low settlement offer (playing soft). It is shown that social welfare would be improved if the victim were committed to take a tougher stance in negotiations and, consequently, more cases went to trial. Three legal policies to help align the private and social motives to settle are discussed: litigation subsidies, punitive damages, and the English Rule for allocating legal costs.

Chapter 4 Litigation

Abstract The purpose of this chapter is to survey the academic literature on the economics of litigation and to synthesize its main themes. The chapter begins by introducing the basic economic framework for studying litigation and out-of-court settlement. One set of issues addressed is positive (or descriptive) in nature. Under what conditions will someone decide to file suit? What determines how much is spent on a lawsuit? When do cases settle out of court? Important normative issues are also addressed. Are the litigation decisions made by private parties in the interest of society as a whole? Next, the chapter surveys some of the more active areas in the litigation literature. Topics include rules of evidence, loser-pays rules, appeals, contingent fees for attorneys, alternative dispute resolution, class actions, and plea bargaining.

Capital structure, priority rules, and the settlement of civil claims

Capital structure affects the bargaining position of a firm in the settlement of civil litigation when the civil judgment may cause the firm to become insolvent. We analyze this pretrial bargaining game under different bankruptcy priority rules. A leveraged capital structure can benefit the firm’s shareholders for two reasons. Most obviously, if the civil plaintiff will not receive top priority in bankruptcy, debt may serve to directly dilute the value of the civil claim. A more subtle effect, however, arises because the cost of a large civil judgment may be borne by the debtholders in bankruptcy. This can make the shareholders into tougher bargainers by narrowing the settlement range. This latter effect implies that even unsecured debt may be used strategically to dilute the value of civil claims, even when the civil plaintiff is given priority in bankruptcy. Welfare and legal implications are discussed.

'Tied to the Mast': Most-Favored-Nation Clauses in Settlement Contracts

Many settlement contracts in lawsuits that involve either multiple plaintiffs or multiple defendants include so‐called most‐favored‐nation (MFN) clauses. If a defendant who faces multiple claims, for example, settles with some plaintiffs early and settles with additional plaintiffs later for a greater amount, then the early settlers will receive the more favorable terms as well. This paper presents two frameworks for evaluating the private and social desirability of MFN clauses. First, MFN clauses can mitigate asymmetric‐information problems and encourage cases to settle earlier. While avoiding delayed settlement is privately and socially desirable, it is shown that the litigation rate may rise. Second, MFN clauses may be used as a bargaining tool for extracting value from future plaintiffs, leading to breakdowns in future negotiations. In both frameworks, the private incentives to use MFN clauses may diverge from the interests of society as a whole.

Should Consumers be Permitted to Waive Products Liability? Product Safety, Private Contracts, and Adverse Selection

A potentially dangerous product is supplied by a competitive market. The likelihood of a product-related accident depends on the unobservable precautions taken by the manufacturer and on the type of the consumer. Contracts include the price to be paid by the consumer ex ante and stipulated damages to be paid by the manufacturer ex post in the event of an accident. Although the stipulated damage payments are a potential solution to the moral hazard problem, firms have a private incentive to reduce the stipulated damages (and simultaneously lower the up front price) in order to attract the safer consumers who are less costly to serve. The competitive equilibrium–if an equilibrium exists at all–features suboptimally low stipulated damages and correspondingly suboptimal levels of product safety. Imposing tort liability on manufacturers for uncovered accident losses–and prohibiting private parties from waiving that liability– can improve social welfare.