Abstract

http://ssrn.com/abstract=10577
 


 



Path Dependent Inefficiency in the Corporate Contract: The Uncertain Case with Less Certain Implications


Frederick W. Lambert


University of California, San Francisco (UCSF); University of California Hastings College of the Law

February 1998


Abstract:     
Professor Lambert examines path dependence as a potential "new economics" having possible general implications for the normative basis of the corporation as nexus of contracts. He introduces the discussion by reviewing the parallel scholarship of contracts and corporate law as they utilize efficiency to reshape theory. He then addresses the concept of path-dependent lock-in to suboptimal remediable results built on the phenomenon of increasing returns. The sharp deviation from neoclassical economics evinced by path dependence prompts an analysis of scholarly criticism suggesting the highly unlikely occurrence of remediable suboptimality. Using the critical literature as a point of departure, he assesses the validity of path dependence to the contracting process, first generally, and then in connection with the literature that has focused specifically on the bond indenture. He suggests that the case has not been made for the general application of path dependence to the contracting process, but unique attributes of certain contracts, such as the corporate bond indenture, may exist in a unique environment conducive to path-dependent suboptimality. Evaluating the normative implications of path dependence that follow from potential contractual inefficiency, he turns to penalty default rules of interpretation as an antidote to inefficiency. He speculates whether Courts should adopt a passive remedial stance -- in essence a penalty default rule -- to encourage ex ante adoption of optimal terms, thus conserving ex post public judicial resources. To test the vitality of penalty defaults he considers three prominent bondholder disputes. The analysis of the cases leads to the tentative conclusion that the effect of judicial decisions on the adoption of indenture provisions is indeterminate and at most secondary to the pricing mechanism of the bond market, which accords relatively little importance to bond covenants other than interest rate, maturity and call provisions. He concludes that, even in an environment susceptible to adoption of inefficient indenture terms, courts will likely have a small role to play in encouraging efficiency in the development of indenture terms.

working papers series





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Date posted: September 25, 1998  

Suggested Citation

Lambert, Frederick W., Path Dependent Inefficiency in the Corporate Contract: The Uncertain Case with Less Certain Implications (February 1998). Available at SSRN: http://ssrn.com/abstract=10577

Contact Information

Frederick W. Lambert (Contact Author)
University of California, San Francisco (UCSF) ( email )
Third Avenue and Parnassus
Hastings College of Law
San Francisco, CA 94143
United States
415-565-4617 (Phone)
415-565-4865 (Fax)
University of California Hastings College of the Law ( email )
200 McAllister Street
San Francisco, CA 94102
United States

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