INTERNATIONAL SCHOOL OF ECONOMIC RESEARCH
XIII Workshop
ECONOMICS AND LAW
RIASSUNTI DELLE RELAZIONI ED ALTRO MATERIALE DIDATTICO/
ABSTRACTS AND OTHER TEACHING MATERIAL
updated
28 June
Session 1
ECONOMICS AND THE THEORIES OF LAW
Jules Coleman Yale Law School
Function and Explanation
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teaching material
This lecture will focus on a variety of issues on the economic theory of
rights and law. I will first characterize various notions of efficiency, and
then explore their connection to familiar moral ideals: utilitarianism and
autonomy. Then I will discuss the application of efficiency to understanding
our legal practices. I will focus primarily on tort law and our practices of
rendering repair for harm. I will show that economic analysis has less of a
role to play in our understanding of our duties to compensate those we injure
than it claims to have.
Robert Cooter UC Berkeley
Should Courts Deduct Non-legal Sanctions from Damages? Law and Economics in
Conflict
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When legal and social norms regulate the same behavior, wrongdoing can
trigger both legal and non-legal sanctions. We analyze their effects on victims
and injurers. The law typically compensates victims, which erodes their
incentives. In contrast, non-legal sanctions typically punish injurers without
compensating victims, which preserves victims’ incentives. Turning to injurers,
when liability for compensatory damages combine with non-legal sanctions, the
total sanction typically over-deters injurers. To avoid over-deterrence, courts
should ideally deduct the external benefit of the non-legal sanction from
compensatory damages. In practice, however, courts concerned with improving
injurers’ and victims’ incentives should deduct, not the external benefit, but
the burden of the non-legal sanction on the wrongdoer. We make practical
suggestions to implement this proposal that would significantly reduce the
damages awarded by courts in many cases.
Ugo Pagano Università di Siena
Public markets, private orderings and corporate governance
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Pagano.doc
In the New Property Rights approach the degree of incompleteness of markets
is taken independently of the cost of the public ordering and of their
efficiency relatively to private orderings. In this approach “public markets”, similarly to a Swiss
cheese, are either assumed to be non-existent empty holes (because of infinite
third party verification costs) or assumed to be smooth and efficient (because
of zero third party verification costs). When we allow for positive but not
infinite third party verification costs we are necessarily pushed back to the
insights of Commons, Coase, Fuller and Williamson. The degree of
(in)completeness of public markets becomes an endogenous economic problem and
managers can be seen as agents that make “second order” specific investments to
run specific relations that cannot be efficiently run by public markets.
Managers and the public authorities build respectively private and public
“legal equilibria” that set the working rules within which transactions can
take place. Private and public legal equilibria are not only substitutes but
also complements. This complementarity is an important source of the path
dependency that characterises the development of different legal systems. The
framework is applied to GM’s acquisition of Fisher Body. We claim that,
contrary to the claims of the New property Rights approach, the advantages of
the acquisition cannot be due to the incentives of private property but should
be rather related to the replacement of public markets by the new private
ordering set up by Alfred Sloan.
Lorenzo Sacconi LIUCC Castellanza
Constitutional principles and incomplete contracts: what constitutional
economics may provide for deciding under uforeseen contingiencies and
constraining abuse of authority?
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Thomas Ulen University of Illinois
New paths in the economic analysis of law
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Ulen.doc
Law and economics has been the most successful innovation in legal
scholarship of the twentieth century. After a brief survey of how the economic
analysis differs from traditional legal analysis, we shall discuss why the
economic analysis of law has been so successful and what some of its most important
accomplishments have been. Then we
shall turn to a discussion of some new trends in law and economics, such as the
increasing importance of empirical studies and of behavioral economics. Finally, we shall discuss some
interesting open issues in the economic analysis of law, such as the role of
legal institutional structure in fostering economic efficiency, the
relationship between law and economic growth, and the use of economics to
examine comparative law issues
Session 2
THE LEGAL BASIS OF ECONOMIC DEVELOPMENT
Fabrizio Barca Ministero
del Tesoro, GISES Siena
Towards a “neo-institutional” territorial development policy
The growing body of economists and policy makers that recognises –
alongside the old and new geography - that development is also driven by
externalities of historically determined agglomerations increasingly advocates
implementing incentive policies in the presence of greater capital and highly
skilled labour mobility. This is in order to make peripheral territories
temporarily end "artificially" more attractive. The existence of
spillover effects and the concern for possible rent-shifting destructive
competition among territories, lead them to suggest entrusting these policies
to central governments. Drawing from the experience of a 2000-2006 plan for
public investment in Southern Italy, an alternative view is presented. First,
it is argued that for externalities to exist physical agglomerations of firms
must be accompanied by a dense network of market and non-market relations among
those firms and that in developed countries this latter feature is often what
peripheral areas lack. Second, like the old geography and unlike the new, it is
argued that natural and cultural local resources should not be considered as
exogenous; their availability for marketable production and for attracting
capital depends on public intervention. A territorial public investment policy
aimed at increasing agglomerations relational density and making natural and
cultural resources more “accessible” is then called for as an alternative to
incentive policies. This alternative policy has relevant implications for the
governance of development interventions because of the geographically
idiosyncratic knowledge that it requires. Unlike in the incentive scenario, a
relevant share of responsibilities must be shifted to local governments, with
the central government retaining responsibilities for devising and enforcing
protocols for the evaluations of costs and benefits of public investments and
for the allocation of resources among regions and broadly defined targets. The
incompleteness of "contracts" arising between central and local
governments also requires the implementation of institutional partnerships:
this trend is emerging in those countries where the limits of new public
management have been more clearly experienced.
Pier
Giuseppe Monateri Università di Torino
Legal Formant
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Monateri.doc
Douglas North Washington University in St. Louis
Law and economics in historic perspective
I plan in my lectures to provide an historical background to the
development of economies and its relationship to law and the growth of a legal
system. To do that I shall probably spend a good part of my time in economic
history exploring the evolution of markets and the way they have evolved and
how that evolution has depended upon the ability to be able to have impersonal
exchange and that in turn has required the development of a complex
institutional structure of which the rule of law has been a critical part
Session
3
PROPERTY RIGHTS, PRIVATE ORDERINGS AND GOVERNANCE
Luca Anderlini, Leonardo Felli University of Southampton, London
School of Economics
Transaction Costs and the Robustness of the Coase Theorem
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Anderlini_Felli.pdf
This paper explores the extent to which the presence of ex-ante transaction
costs may lead to failures of the Coase Theorem. In particular we identify and investigate the basic
"hold-up problem" which arises whenever the parties to a Coasian
negotiation have to pay some ex-ante costs for the negotiation to take place. We
then show that a "Coasian solution" to this hold-up problem is not
available. This is because a Coasian solution to the hold-up problem typically
entails a negotiation on the payment of the costs associated with the future
negotiation which in turn is associated with a fresh set of ex-ante costs, and
hence a new hold-up problem.
Fabrizio Cafaggi Università di Trento
A characterisation
of observability and verifiability in contracts
Nicola Dimitri Università di Siena
A characterisation of observability and verifiability in contracts
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Dimitri.doc
In the paper we first provide a definition and then a characterisation,
in terms of relevant state spaces, of observability and verifiability, two
fundamental and recurrent notions in the theory of contracts. Typically, in the
literature, both observability and verifiability appear to refer to correct
detection of the events-contingencies specified in the contract. However, in
the work, we conceive this correct detection to be different in the two
cases. Indeed, a sense in which
observability seems to be intended evokes, when they obtain, self-evidence of
contract contingencies. However, when no contract contingency obtains no
request, beyond that of not drawing the wrong decision that a contract event
has occurred, is apparently imposed upon parties’ information processing
skills. Alternatively, when a true state does not belong to the contract space,
correct detection of it would not necessarily be asked to parties.
Consequently, parties may find themselves in the position of not believing that
any contract event obtained without necessarily understanding why. This ought
not be true when verifiability is considered. In case of conflict among
parties, the court should not only emit a correct verdict but also properly
motivate it. Therefore, if a state
not contemplated in the contract were the true one, the court would have to
properly explain to parties that the case has to be dismissed just because no
contract contingency applies. The main result of the paper says that for any
contract to be verified the court’s state space must be included in the true
state space.
Nancy Gallini University of Toronto
The lecture will cover a variety of topics in the fascinating area of
the law and economics of intellectual property. The economic justification for
the intellectual property laws will be reviewed and alternative mechanisms for
protecting intellectual property such as prizes, contracts, auctions and
renewal fees will be examined. We will focus on the growing and insightful literature on sequential innovation.
Moreover, we will examine the impact of intellectual property rights on the
organization of innovative activity and the incentives to license. Private
mechanisms for appropriating the returns from R&D investment (contractual
restrictions, cross-licensing, vertical integration, litigation) will be
discussed along with the role of antitrust in mitigating potential
anti-competitive abuses from these private arrangments.
Katsuhito Iwai University of Tokyo
What is a corporation? The corporate personality controversy and
comparative corporate governance
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Iwai.doc
The law speaks of a corporation as a ‘legal person’ -- as a subject of
rights and duties capable of owning real property, entering into contracts, and
suing and being sued in its own name separate and distinct from its
shareholders. For many centuries there have been a heated controversy between
corporate nominalists and corporate realists as to the ‘essence’ of this
soulless and bodiless person. The
first purpose of this lecture is to end this age-old ‘corporate personality
controversy’ once and for all. It
is, however, not by declaring victory for one side or the other, but by
declaring victory for both. The
key to this claim is the observation that an incorporated firm is composed of
not one but two ownership relations: the shareholders own the corporation and
the corporation in turn owns the corporate assets. The corporation thus plays a dual role of a ‘person’ and a
‘thing’ in the system of law. This
lecture then shows how this person/thing duality of corporation is capable of
generating two seemingly contradictory corporate structures -- one
‘nominalistic’ and the other ‘realistic.’
It also suggests that these two variants of corporate structure respectively
correspond to an American-style corporation that is expected to maximize the
returns to shareholders and a Japanese-style corporation that strives to
reproduce its organization as a going concern. The second purpose of this
lecture is to reexamine the theory of corporate governance. The fact that an incorporated firm is
characterized by two-tier ownership structure implies that corporate managers
cannot be regarded as agents of shareholders. They are instead ‘fiduciaries’ of the corporation. Indeed, this lecture advocates the
return to the pre-Law&Economics orthodoxy, maintaining that the foundation
of every corporate governance system should be the managers' fiduciary duties
to the corporation and that the law governing these duties should be essentially
mandatory. It also argues that a
variety of corporate governance systems across countries is due to the
difference in governance mechanisms that supplement the costly implementation
of fiduciary law by courts.
Antonio Nicita Università di Siena
Endogenous (dis)integration, and the institutional complexity of contract
enforcement. Beyond the market-contract trade-off
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Nicita.doc
The paper is an extension of
the contributions provided by Aghion and Bolton (1987), Chung (1994,
1996), and Spier and Whinston (1995) – among others - to the analysis of the trade-off between the enforcement of incomplete
contracts characterised by specific investments and the market foreclosure
deriving from the resulting high exit costs. When specific investments are made
by the incumbent agent, potential competition will affect the incentive to
efficiently invest depending on the nature and the extent of the breach
penalties enforced by external authorities. We will conclude that in an
incomplete contract framework with unverifiable specific investments but
verifiable exit options, the degree of assets specificity in a contractual
relationship depends on the nature of the breach penalties enforced by external
authority and on the expected efficiency of potential competitors. In such a
context antitrust authorities are called to evaluate the market efficiency
induced by the penalty regime adopted and the impact of the strategic selection
of technological innovations on competitors entry. A summarisation of the
economic principles involved in the antitrust case United States v. United Shoe
Machinery Corporation will clarify the nature of such a trade-off. The paper
shows how in an incomplete contract with specific investments, dependin on the degree of ex-post
market competition induced by the type (specific or general-purpose) of
investment made, each agent might reach a monopolistic position by deterring
his competitors and/or by encouraging contractual counterpart’s competitors; as
a consequence even in an incomplete contract, agents may both overinvest in
assets’ specificity and use specific investments as a strategic discipline
device in order to deter counterpart’s post-contractual opportunism. The
resulting complex institutional context, coined as cross competition, provides
straightforward explanations for the anti-competitive effect generated by
vertical integration and for the enforcement effect generated by collusion
among competitors. It is then argued that vertical and purely horizontal
restraints share the same potential pro and anti-competitive effects, depending
on the institutional and technological context which is assumed. Such an approach
allows for an alternative explanation – in sharp contrast with the huge
literature on strategic deterrence and market dominance – of the role of sunk
investments as strategic deterrence devices against potential competitors.
Alan Schwartz Yale University
Contracts
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paper
These Lecture Notes ask two questions: (A) Why should the state enforce
private agreements? and (B) What roles regarding private agreements should the
state play in addition to legal enforcement? Regarding question (A),
enforcement permits parties who function in relatively large economies to make
credible promises to perform their agreements. The inability to make credible promises would severely limit
parties’ ability to make short term supply contracts in volatile markets and to
make long term supply contracts; and it would also severely limit parties’
ability to contract for the making of investments that are more productive in a
contractual relationship than those investments would be elsewhere. The poor performance of transition
economies with weak legal enforcement evidences the importance of being able to
make credible promises to perform.
Regarding question (B), Western states perform three roles in connection
with enforceable contracts -- they (i) regulate the contracting process; (ii)
supply parties with a stock of default rules to govern transactions; and (iii)
interpret private agreements in the course of resolving disputes. These Notes will argue that the second
function is unimportant and suggest how the first and third of these functions
should be best performed.
Peyton Young Johns Hopkins University
Customary Contracts
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A customary contract is a set of terms that is standard in a given
locale for a given economic purpose. Once established, such a standard tends to
perpetuate itself because it creates expectations about what is fair and
appropriate in a given type of economic bargain. We propose a dynamic model of
how contractual customs form endogenously. Agents are situated in a
geographical or social space, and they recontract periodically based on
expected returns and conformity with local practice. The model predicts that
the most likely geographic pattern consists of "patches" where
contractual terms are nearly uniform, separated by boundaries where contractual
norms jump from one set of terms to another. We compare these predictions with
contractual practice in contemporary Illinois agriculture, and find
considerable support for the model's predictions. - The suggested background
reading consists of my book Individual Strategy and Social Structure (Princeton
University Press, 1998).
Luigi Zingales University of Chicago
Corporate Governance
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Zingales.pdf
Special Session – Conference on
CONTRACT ENFORCEMENT AND INCOMPLETENESS
Leonardo Felli L.S.E with Kevin Roberts (Nuffield College,
Oxford)
Does Competition Solve the Hold-up Problem?
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Felli_Roberts.pdf
In an environment in which both buyers and sellers can undertake match
specific investments, the presence of market competition for matches may solve
hold-up and coordination problems generated by the absence of complete
contingent contracts. In particular, this paper shows that when matching is
assortative and sellers' investments precede market competition then
investments are constrained efficient. One equilibrium is efficient with
efficient matches but also there can be equilibria with coordination failures.
Different types of inefficiency arise when buyers undertake investment before
market competition. These inefficiencies lead to buyers' under-investments due
to a hold-up problem but, when competition is at its peak, there is a unique
equilibrium of the competition game with efficient matches --- no coordination
failures --- and the aggregate hold-up inefficiency is small in a well defined
sense independent of market size.
Andrew Postlewaite University of Pennsylvania with George Mailath
(University of Pennsylvania) and Stephen Morris (Yale University).
Laws and Authority
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Postlewaite.pdf
We argue that a law prohibiting a particular behavior does not directly
change the payoff to an individual should he engage in the prohibited behavior.
Rather, any change in the individual's payoff, should he engage in the
prohibited behavior, is a consequence of changes in other peoples' behavior. If
laws do not directly change payoffs, they are ''cheap talk,'' and can only
affect behavior because people have coordinated beliefs about the effects of
the law. Beginning from this point of view, we provide definitions of authority
in a variety of problems, and utilizing these definitions investigate what
individuals can have, gain, and lose authority, and under what circumstances
Sönje Reiche L.S.E.
Foundations of
Incomplete Contracts: Asymmetric Information and Renegotiation
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Reiche.pdf
Incomplete contracting models often fail to consider revelation
mechanisms that can condition contracts on the announcement of all relevant
information. This paper considers a buyer-seller relationship under one-sided
asymmetric information, where the incompleteness of information leads to
inefficiencies. We show that in the presence of renegotiation the benefit from
writing a complete contract depends on the possible costs and gains from trade.
If costs and benefits lie far apart, there is a role for contracts in raising
efficiency. On the other hand, if costs and benefits are very similar, every
contingent contract is equivalent to the null-contract. The paper therefore
gives a rationale for the intuition that contractual incompleteness may be
attributed to contracting costs. Contracting costs arise endogenously within
the model through incentive constraints and the lack of contractual commitment.
More precisely, incentive considerations in this model force parties to
undertake a detrimental action on the equilibrium path. The loss in total
surplus from this action can be interpreted as the cost of contracting. The
second main finding in the model is that any contract involves
on-the-equilibrium-path renegotiation, thus invalidating the
Renegotiation-Proofness-Principle.
Alan Schwartz Yale University with Joel Watson (University of
California, San Diego)
Economic and Legal Aspects of Costly Recontracting
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Schwartz_Watson.doc
This paper explores how the opportunity to recontract affects investment
and trade in contractual relationships when it is assumed that renegotiation is
costly. In this world, recontracting retains much of the benefit that has been
ascribed to it, including the realization of any surplus that is available ex
post. Costly recontracting also mitigates the well-known drawback, that parties
who expect to renegotiate sometimes cannot credibly commit to invest
efficiently. This is because the attractiveness of renegotiation decreases in
recontracting costs. We show that the optimal contracting environment often
involves moderate recontracting costs, which balance the beneficial and
detrimental effects of renegotiation. Our result stands in contrast to those
derived in common models that assume unrealistically either that recontracting
costs are zero or that they are infinite. We discuss implications for the
design of legal institutions, governance systems, and contractual form.
Giovanni Maggi Princeton University with Pierpaolo Battigalli
(European University Institute)
Imperfect contracting in a long-term relationship
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Battigalli.pdf
We examine a model of contracting where parties interact repeatedly and
can contract at any point in time, but writing is costly. Parties can write
`spot' contracts, i.e. in each period they can contract after observing the
relevant contingencies and before actions are taken. In spite of the fact that
spot contracting avoids the costs of describing contingencies, and there are no
fixed contracting costs, it is optimal to write some form of long-term
contract. In the optimal contract, a group of more important tasks is regulated
either by contingent rules or by `default' rules; a group of less important
tasks is regulated by rigid rules; and the least important tasks are left to
the agent's discretion. Thus, the presence of writing costs can provide a
theoretical explanation (complementary to those already proposed in the
literature) for the use of long-term contracts. We examine how the optimal
contract is affected by the durability of the relationship and by the
uncertainty in the external environment. We then allow for self-enforcing
contracts, i.e. contracts that are enforced by reputation mechanisms rather
than by courts. We assume that self-enforcing contracts require informal
communication, but this is less costly than formal communication (i.e. writing
a contract in such a way that it can be enforced in court). If the costs of informal
communication are not negligible, optimal self-enforcing contracts are
incomplete. We compare the optimal self-enforcing contract with the optimal
formal contract. When we allow for both formal and informal contracts, we find
that they tend to be used jointly. In particular, tasks for which the conflict
of interest between parties is stronger (weaker) tend to be regulated by formal
(informal) contracting. Thus, the presence of writing costs can also contribute
to explain why long-term relationships are often managed by a combination of
formal and informal contracting.
Nabil Al-Najjar Northwestern University with Luca Anderlini
(Southampton University) and Leonardo Felli (L.S.E.)
Incomplete Contracts in a Complex World
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Al-Najjar.pdf
We develop a theory where contractual incompleteness arises as a result of the complexity of the
underlying state space. Using a simple
co-insurance problem as backdrop, we introduce a new model where states
are described in terms of objective, contractible features, and where a
contract must specify the parties' actions/transfers as a function of a finite
number of such features. In this setting, complexity arises when the first-best
varies with features in a complex way that makes it highly sensitive to the
details of each contingency. In our model, although agents can compute expected
payoffs, they are unable to draw-up a contract that captures (even
approximately) the complexity of
the first best in their contractual environment. We characterize the degree of
incompleteness of optimal contracts in terms of the primitives of the agents'
environment showing, in particular, that optimal contracts in highly complex
contractual problems tend to be extremely coarse.
Lucian Bebchuk Harvard University
Contractual Restrictions on Actions that might Harm the Other Side
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Bebchuck.doc
Many standard contracts require one party to get the other party's consent
for certain actions that might potentially harm the other party. Such
restrictions appear, for example, in loan contracts, leases, franchise
agreements, or university rules regulating the activities of faculty members. I
analyze the choice whether to restrict a contracting party's actions,
considering both ex post efficiency and ex ante efficiency. Whereas a
restriction might ex ante lead to under-investment in developing opportunities
to take efficient actions, having no restriction might ex ante lead to
over-investment in developing opportunities to take inefficient actions.
Certain types of reputation, and ability on the part of courts to verify
realized harms, increase the attractiveness of the considered restrictions.
Finally, the analysis provides reasons for the common use of over-broad
restrictions -- restrictions that ex post are often relaxed but rarely
tightened.
Philippe Aghion Harvard University and U.C.L. with Mathias Dewatripont
(ECARES, Bruxelles) and Patrick Rey (IDEI, Toulouse)
Partial Contracting, Control Allocation and Cooperation
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Aghion.pdf
The idea that explicit contracts cannot entirely determine the dynamics
of an economic relationship, and that for example repeated interactions and
reputation-building can play a complementary role in inducing compliance,
loyalty, and cooperation, is now commonly accepted by economic scholars and
policy-makers interested in firms and organizations. More challenging perhaps,
is to analyze the way in which formal contract design can affect the subsequent
relationship between the parties involved. Thus, in recent empirical work,
Banerjee and Duflo (1999) investigate the nature of contracts between buyers
and sellers of customized software in India, and they show that the design of
contracts varies with the age of the software producer, in a way which suggests
that reputation considerations matter: namely, the allocation of risks tends to
be shifted from the seller towards the buyer as the seller's age
increases. In this paper, we want
to analyze how a particular aspect of contract design, namely control
allocation, provides a ''governance structure'' that will affect the dynamic
relationship between the contracting parties, and in particular will induce the
parties to cooperate over time.
Focusing on control allocation as a way to induce cooperation, our
analysis is closely related to the literature on ''formal'' versus ''informal''
contracting, and in particular with Baker et al.(1997) and with Halonen (1997).
In a repeated model of ownership allocation a la Grossman-Hart (1986), Baker et
al. (1997) show that that vertical integration may help the parties to hold on
to their promises of taking costly actions or making costly monetary transfers;
however, this paper is not concerned with foundations and in particular it
rules out message games that would dramatically affect the form of optimal
contracts. Based also on a repeated ownership allocation model, but with
imperfect information about the parties'disutility from cheating on effort or
investment commitmtents, Halonen (1997) argues that joint ownership may emerge
as a desirable contractual outcome ex ante, as it makes it particularly costly
reputationwise for either party to renege on his/her promises. But once again, message games are ruled
out, even though introducing them would greatly affect the results in this
model where trade and cheating are both ex post verifiable. In this paper, we
shall propose a simple framework to discuss these and other ''incomplete
contract-based'' ideas in a well-founded way: in a nutshell, our framework
relies on the notion of partial contracting in contractual relationships
involving ex post unverifiable actions.
Luigi Zingales University of Chicago with Raghuram Rajan
(University of Chicago)
The Firm as a Dedicated Hierarchy: A Theory of the Origin and Growth of
Firms
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Zingales_Rajan.pdf
In the formative stages of their businesses, entrepreneurs have to
provide incentives for employees to protect, rather than steal, the source of
organizational rents. We study how the entrepreneur's response to this problem
determines the organization's internal structure, growth, and its eventual
size. Large, steep hierarchies will predominate in physical-capital intensive
industries, and will have seniority-based promotion policies. By contrast, flat
hierarchies will prevail in human-capital intensive industries and will have
up-or-out promotion systems. Furthermore, flat hierarchies will have more
distinctive technologies or cultures than steep hierarchies. The model points
to some essential differences between organized hierarchies and markets.
Luca Anderlini Southampton University with Leonardo Felli (L.S.E.)
and Andrew Postlewaite (University of Pennsylvania
Courts of Law, Unforeseen Contingencies and Incomplete Contracts
ftp://goodwin.econ-pol.unisi.it/pub/iser00/Anderlini_Felli_Postelwhite.pdf
We study a contracting model with unforeseen contingencies in which the court
is an active player. Ex-ante, the contracting parties cannot include the risky
unforeseen contingencies in the contract they draw up. Ex-post the court
observes whether an unforeseen contingency has occurred, and then decides
whether to void or uphold the contract. If the contract is voided by the court
a new agreement is renegotiated ex-post. We characterize the optimal decision
rule for the court. It is determined by the trade-off between incentives and
insurance that it offers to the agents. A court that voids more contracts has
two effects. The parties' incentives to undertake a relationship-specific
investment are reduced, and the parties can achieve further insurance against
the unforeseen contingencies which the ex-ante contract could not take into
account. We also characterize the equilibrium of the model when there is
asymmetric information about the unforeseen contingencies. If knowledge of the
unforeseen contingencies is sufficiently correlated with "bad news'', we
find that, in equilibrium, the informed party will not reveal any information
(verifiable or not) to the other side. We interpret this equilibrium as one in which
endogenously incomplete contracts obtain. Some contingencies will be ignored by
the equilibrium contracts, even though the parties' pooled information is
sufficient to take them into account.
Oliver Hart Harvard University with John Moore (L.S.E.)
On the Design of Hierarchies: Coordination versus Specialization
We develop a model of hierarchies based on the allocation of authority. A firm's owners have
ultimate authority over a firm's decisions, but they have limited capacity or
desire to exercise this authority. Hence owners may defer to subordinates.
However, these subordinates also have limited capacity or desire to exercise
authority, and so they may defer to their subordinates. We analyze the optimal
chain of command given that different agents have different tasks: some agents
are engaged in coordination and others in specialization. Our theory throws
light on the nature of hierarchy, the optimal degree of decentralization, and
firm boundaries.