Path Dependence in Corporate Contracting: Increasing Returns, Herd Behavior and Cognitive Biases

Washington University Law Quarterly, Vol. 74, Issue 2 (1996).

Posted: 3 Jun 1998

See all articles by Marcel Kahan

Marcel Kahan

New York University School of Law; European Corporate Governance Institute

Michael Klausner

Stanford Law School; European Corporate Governance Institute (ECGI)

Abstract

In prior articles, we have argued that corporate contract terms may frequently involve learning and network externalities. These externalities result in "increasing returns," which can lead to path dependence and social suboptimality in contract terms. In this article, we expand our prior analysis by investigating two additional forces that may lead to the standardization of suboptimal terms: agency costs and related herd behavior among lawyers, and cognitive biases. Agency costs associated with lawyers serving as draftsman stem from a divergence that can exist between the value of a contract term to a client firm and its impact on the draftsman's reputation. Among other things, this divergence can lead to herd behavior in the use of standard terms, as lawyers seek to protect their reputation by employing the same standard terms that other lawyers have used. Cognitive biases -- in particular status quo bias, anchoring bias, and conformity bias -- can also lead parties to employ standard contract terms that are suboptimal both socially and for the parties to the contract.

JEL Classification: G32, G34

Suggested Citation

Kahan, Marcel and Klausner, Michael D., Path Dependence in Corporate Contracting: Increasing Returns, Herd Behavior and Cognitive Biases. Washington University Law Quarterly, Vol. 74, Issue 2 (1996)., Available at SSRN: https://ssrn.com/abstract=10087

Marcel Kahan (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
212-998-6268 (Phone)
212-995-4341 (Fax)

European Corporate Governance Institute ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Michael D. Klausner

Stanford Law School ( email )

559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-723-6433 (Phone)
650-725-0253 (Fax)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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