Coming to the Nuisance: An Economic Analysis from an Incomplete Contracts Perspective

Abstract:     
We construct a model in which a first mover decides on its location before it knows the identity of the second mover; joint location results in a negative externality. Contracts are inherently incomplete since the first mover's initial location decision cannot be specified to an anonymous second mover. The allocation of property rights over the externality has real effects on social welfare. The "coming to the nuisance" rule, which allocates property rights to the first mover, protects the first mover's investment from expropriation, but may lead it to invest excessively, and thus may be dominated by second-mover rights. In contrast to conventional wisdom, inefficiencies still arise even if a monopoly landowner controls all the land on which the parties may locate. We derive optimal rights regimes, but the focus of our analysis is on property rights regimes used in practice, an analysis which leads us to challenge a number of established results in law and economics including the Calabresi-Melamed rule on injunctions versus damages, the efficacy of rights contingent on land-improving investment, and Coase's insight on the irrelevance of the identity of the polluter.

JEL Classifications: K11, D23, C78, H23

Working Paper Series