Abstract

http://ssrn.com/abstract=295659
 
 

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The Law and Economics of Costly Contracting


Alan Schwartz


Yale Law School

Joel Watson


University of California, San Diego (UCSD) - Department of Economics

December 2001

Yale Law & Economics Research Paper No. 264

Abstract:     
In most of the contract theory literature, contracting costs are assumed either to be high enough to preclude certain forms of contracting, or low enough to permit any contract to be written. Similarly, researchers usually treat renegotiation as either costless or prohibitively costly. This paper addresses the middle ground between these extremes, in which the costs of contracting and renegotiation can take intermediate values and the contracting parties can themselves influence these costs. The context for our analysis is the canonical problem of inducing efficient relation-specific investment and efficient ex post trade. Among our principle results are: (i) The efficiency and complexity of the initial contract are decreasing in the cost to create a contract. Hence, the best mechanism design contracts can be too costly to write. (ii) When parties use the simpler contract forms, they require renegotiation to capture ex post surplus and to create efficient investment incentives. In some cases, parties want low renegotiation costs. More interesting is that, in other cases, parties have a strict preference for moderate renegotiation costs. (iii) The effect of Contract Law on contract form is significant but has been overlooked. In particular, the law's interpretive rules raise the cost of enforcing complex contracts, and thus induce parties to use simple contracts. Worse, the law also lowers renegotiation costs, which further undermines complex contracts and is also inappropriate for some of the simpler contracts.

Number of Pages in PDF File: 47

Keywords: Contracts, contracting costs, renegotiation, investment, contract law

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Date posted: January 4, 2002  

Suggested Citation

Schwartz, Alan and Watson, Joel, The Law and Economics of Costly Contracting (December 2001). Yale Law & Economics Research Paper No. 264. Available at SSRN: http://ssrn.com/abstract=295659 or http://dx.doi.org/10.2139/ssrn.295659

Contact Information

Alan Schwartz (Contact Author)
Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-4030 (Phone)
203-432-8260 (Fax)
Joel Watson
University of California, San Diego (UCSD) - Department of Economics ( email )
9500 Gilman Drive
La Jolla, CA 92093-0508
United States
858-534-6132 (Phone)
619-534-7040 (Fax)
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