“Should Courts Always Enforce What Contracting
Parties Write?”
Georgetown University, mimeo, 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.
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