The Return of Bargain: An Economic Theory of How Standard Form Contracts Enable Cooperative Negotiation between Businesses and Consumers

Abstract:     
This paper analyzes standard form contracts between firms and individual consumers (and borrowers). It presents a mix of anecdotal and empirical evidence from a large number of industries demonstrating a widespread pattern in which firms refrain from enforcing the typically clear bright line performance obligations that such standard form contracts set out (such as a consumer credit repayment terms, or a retail consumer's right to return goods). Instead, firms routinely give their supervisory employees the discretion to bargain around such terms. Within a simple and informal model, the paper explains such delegated, discretionary renegotiation as a means by which firms use their managers' superior information to ex post screen for consumer type. Managers forgive breaches of contract terms by high value, honest consumers, while enforcing the tough standard form terms against low value and/or opportunistic consumers. While such practices may be vulnerable to market competition in the long run (as cut-rate firms eschew such costly renegotiation, lowering cost and price and attracting low value consumers), they may also be a stable competitive practice. Normatively, such ex post screening dominates ex ante screening by opening markets to consumers who would otherwise be denied goods or services provided on credit because they have low wealth and/or no established market reputation. Taking account of possible firm opportunism as well as consumer opportunism, the central normative implication for the law is to recommend that courts enforce promises by the firm's agents to waive or renegotiate standard form obligations, but only if there is clear proof that such promises were actually made. The paper concludes with by arguing in favor of the judicial enforcement of standard form terms regarding the settlement of disputes - such as terms requiring that disputes be resolved by arbitration. Such provisions allow consumer value, rather than ex post litigation outcomes, to be the primary determinant of firm incentives to forgive consumer breaches of performance obligations. However, because consumers remain rationally ignorant of terms regarding dispute resolution, courts have been correct to strike down terms that effectively eliminate all consumer remedies.

Keywords: standard form contracts, consumer screening, reputation, opportunism, renegotiation, consumer contracts, consumer complaints, return policies

JEL Classifications: K00, K12, I14

Working Paper Series