Coming to the Nuisance: An Economic Analysis from an Incomplete Contracts Perspective
Posted: 12 Jun 2003
We construct a model in which an investment opportunity arises for a first mover before it knows the identity of a second mover and in which joint location results in a negative externality. Contracts are inherently incomplete since the first mover cannot bargain over its ex ante investment decision with the anonymous second mover. Given this departure from the setting of the Coase Theorem, the allocation of property rights over the externality has real effects on social welfare. We investigate the relative efficiency of property rights regimes used in practice: injunctions, damages, the ruling in the Spur Industries case, etc. The first best can be obtained by allocating property rights (in particular the right to sue for damages) to the second mover. Allocating property rights to the first mover, as a "coming to the nuisance" rule entails, leads to overinvestment. In contrast to conventional wisdom, this inefficiency persists even if a monopoly landowner controls all the land on which the parties may locate.
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