Optional Law in Property: Theoretical Critiques

Abstract

Since Calabresi & Melamed’s seminal article on property rules and liability rules, numerous law and economic articles have debated the efficiency of these two rules. Many of the follow-up articles contend that Calabresi & Melamed are wrong in arguing that property rules are more efficient when transaction costs are low. Put-option liability rules and other sub-types of liability rules have been developed, and they are claimed to be superior to property rules. As several property scholars have pointed out, however, the shadow examples in this so-called optional law literature are not property laws, and they have contended that property rules should be the default in property law. Built on this line of literature, this article argues that Calabresi & Melamed are actually correct — property rules are indeed more efficient than liability rules in property law in a low transaction-cost setting, because property rules better harness private information. In addition, this article develops a theory as to when call-option liability rules might be more efficient. This article also argues that Rules 3 and 4 are either unnecessary concepts or inefficient entitlement protection rules in the area of property, and that put-option liability rules are less efficient than call-option liability rules in property, because calls utilize private information better than puts. Finally, this article contends that liability rules are intrinsically different from financial options and legal options; thus, the option analogy is better avoided.

Keywords: Property rule, liability rule, call option, put option, transaction costs, private information, optional law, investment

JEL Classification: K11