Courts and Contractual Innovation: A Preliminary Analysis
FRB of Philadelphia Working Paper No. 05-27/R
31 Pages Posted: 22 Dec 2005
Date Written: December 2005
We explore a model in which agents enter into a contract but are uncertain about how a judge will enforce it. The judge can consider a wide range of evidence, or instead, use a rule-based method of judgment that relies on limited information. We focus on the following tradeoff: Considering a wide range of evidence increases the likelihood of a correct ruling in the case at hand but undermines the formation of precedents that resolve legal uncertainty for subsequent agents.
In a model of contractual innovation, we show that the use of evidence increases the likelihood of innovation in any period, while rule-driven judgments increase the rate of diffusion of the innovation. When courts can use a mixture of evidence and rules, the minimum amount of evidence that induces adoption is (weakly) decreasing over time. We also examine the breadth of precedents. Overlapping jurisdictions reduce the optimal breadth of precedents because broad precedents are more likely to introduce conflict. Accordingly, overlapping jurisdictions increase the value of using evidence. We use our model to interpret differences between the legal systems in the U.S. and England.
Keywords: courts, contracts, innovation, evidence, precedents, legal systems
JEL Classification: D86, K00, K12, K40
Suggested Citation: Suggested Citation