49 Pages Posted: 11 Jul 2000
Date Written: June 1999
This article analyzes how legal presumptions can mediate between costly litigation and ex ante incentives. We augment a moral hazard model with a redistributional litigation game in which a presumption parameterizes how a court 'weighs' evidence offered by the opposing sides. Strong prodefendant presumptions foreclose lawsuits altogether, but also engender shirking. Strong proplaintiff presumptions have the opposite effects. Moderate presumptions give rise to equilibria in which both shirking and suit occur probabilisitically. The socially optimal presumption trades off agency costs against litigation costs, and could be either strong or moderate, depending on the social importance of effort, the costs of filing suit, and the comparative advantage that diligent agents have over their shirking counterparts in mounting a defense. We posit three applications of our model: the litigation rate effects of the 1995 Private Securities Litigation Reform Act, the business judgment rule in corporations law, and fiduciary duties in financially distressed firms.
JEL Classification: D81, D82
Suggested Citation: Suggested Citation
Bernardo, Antonio E. and Talley, Eric L. and Welch, Ivo, A Theory of Legal Presumptions (June 1999). Journal of Law, Economics, and Organization, Vol. 16, No. 1, Spring 2000. Available at SSRN: https://ssrn.com/abstract=202354