Good Law & Economics Needs Suitable Microeconomic Models: The Case Against the Application of Standard Agency Models to the Professions
University of Trento - Department of Economics and Management
February 20, 2007
Notwithstanding its widespread acceptance, agency theory could not be the most suitable microeconomic modeling for designing efficient and fair economic transactions. The case against the standard principal-agent modeling is made about liberalizations of professional services that introduced schemes of professionals' remuneration contingent on outcomes - i.e. "contingent fees" for lawyers. If the relationship between the professional and clients is seen according to the principal-agent model, contingency fees can be an efficient incentive for the professional's effort. The case is quite different, however, if the situation is seen as one of bounded rationality and unforeseen and asymmetrically gathered events. In these contexts they can generate pathological incentives.
The professional relationship is an authority relationship based of contractual incompleteness, which requires the reliance on trustworthiness of the authority position's holder. Hence I propose a model for understanding the professional relationship which extends the "formal vs. real authority" model proposed by Aghion and Tirole (1997). This leads to underline the essential role played by behavioral hypothesis on professionals' "endogenous" adherence to ethical standards that induces the professional's identification with her clients' interests.
A game theoretical thought experiment is then carried out. It shows that (i) in the case of a self-interested lawyer contingent fees lead to not respecting the fiduciary obligations with at least one client for only the ex post mostly remunerative cases are litigated. (ii) In the case of the lawyer's willingness to comply with deontology standards, contingent fees lead nevertheless to neutralization of the deontological motivation and to a loss of efficiency. A Pareto optimal, impartial, as well as efficient, arrangement aimed at maximizing the total volume of damage compensation is then considered. Nevertheless under a contingent fees contract, even if these motivations were available, the professional could not carry out them because of the logic of the contract.
Number of Pages in PDF File: 71
Keywords: lawyers' contingent fees, principal-agent, incomplete contracts, authority, professional ethics, fiduciary duties, reciprocity, conformist preferences
Date posted: February 22, 2007