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A Safety Valve Model of Equity as Anti-Opportunism

37 Pages Posted: 7 Apr 2013 Last revised: 28 Apr 2013

Kenneth Ayotte

University of California, Berkeley - School of Law

Ezra Friedman

Northwestern University - Pritzker School of Law

Henry E. Smith

Harvard Law School

Date Written: March 30, 2013

Abstract

In this paper, we argue that the notion of equity as a safety valve on the law can be seen as part of the law’s response to the problem of opportunism. We define equity as the use of a more flexible, morally judgmental, and subjective mode of legal decision making that roughly corresponds with historical equity. We distinguish opportunists as agents who have unusual willingness and ability to take advantage of necessary imperfections in the law. We present a simple contracting model that captures the role of equity as a safety valve, and show how it can solve problems posed by opportunists. In our model, a simple but imperfect formal legal regime is able to achieve first best in the absence of opportunists. But when opportunists are added, a more flexible regime (equity) – specifically, one that denies damages to parties who exploit contractual gaps – can be preferred. However, equity is also vulnerable to being used opportunistically by the parties it intends to protect. For this reason, we show that it is often preferable to limit equity, reserving it for use only against those who appear sufficiently likely to be opportunists. Our model generates intuitive comparative statics that describe the optimal expansiveness or restrictiveness of equity.

Keywords: law and equity, contracts, opportunism

JEL Classification: K00, K10, K12, K40

Suggested Citation

Ayotte, Kenneth and Friedman, Ezra and Smith, Henry E., A Safety Valve Model of Equity as Anti-Opportunism (March 30, 2013). Northwestern Law & Econ Research Paper No. 13-15. Available at SSRN: https://ssrn.com/abstract=2245098 or http://dx.doi.org/10.2139/ssrn.2245098

Kenneth Ayotte (Contact Author)

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

Ezra Friedman

Northwestern University - Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States

Henry E. Smith

Harvard Law School ( email )

1575 Massachusetts
Hauser 406
Cambridge, MA 02138
United States

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