*George Mason School of Law

Contracts I

Why Enforce Contracts

F.H. Buckleyfbuckley@gmu.edu

Next DayContract Law in the State of Nature*

*Contracts I

Why Enforce Contracts

*Contracts I

Why Enforce ContractsWhere Contracts Should Not Be Enforced

*Contracts I

Why Enforce ContractsWhere Contracts Should Not Be EnforcedFormation of Contracts

*Contracts I

Why Enforce ContractsWhere Contracts Should Not Be EnforcedFormation of ContractsConsideration

*Contracts I

Why Enforce ContractsWhere Contracts Should Not Be EnforcedFormation of ContractsConsiderationRelational Contracts

*A Law and Econ PerspectiveTony Kronmans CommentDean Henry Manne,George Mason Insider Trading and the Stock Market 1965

*A Law and Econ PerspectiveLe mot de Tony KronmanRonald Coase, U. of ChicagoThe Problem of Social Cost 1960Dean Henry Manne,George Mason Insider Trading and the Stock Market 1965*

*A Law and Econ PerspectiveLe mot de Tony KronmanRonald Coase, U. of ChicagoThe Problem of Social Cost 1960Dean Henry Manne,George Mason Insider Trading and the Stock Market 1965Hon. Richard PosnerUniversity of ChicagoEconomic Analysis of Law 1973

*

A Preliminary QuestionWho cares if we enforce contracts?

The nihilism of the 1970s: Whats wrong with this contract?If one person does not lose, the other does not gain. Augustine*

A Preliminary QuestionWho cares if we enforce contracts?

The nihilism of the 1970s: Whats wrong with this contract?Consumerism: Its always Williams v. Walker-Thomas*

The Young LawyersABC 1970-71*

*So why enforce contracts?Casebook suggests two principles

An Autonomy Principle

The Efficiency Norms of Law and Economics

Autonomy

How am I more free if I subject myself to fetters?

*

Autonomy

How am I more free if I subject myself to fetters?

Ex post vs. ex ante*

Promising and Efficiency Norms

The benefit afforded by promissory institutions is a greater assurance of performanceWhich is strengthened when contractual sanctions are added to moral ones.

*

Promising and Efficiency Norms

The benefit afforded by promissory institutions is a greater assurance of performance

So why is that important?*

Promising and Efficiency Norms

The benefit afforded by promissory institutions is a greater assurance of performance

So why is that important?Lets assume that contract enforceability has something to do with societal wealth*

*

*

Heritage Ranking of Economic Freedom*

1Hong Kong89.70.02Singapore87.21.13Australia82.5-0.14New Zealand82.30.25Switzerland81.90.86Canada80.80.47Ireland78.7-2.68Denmark78.60.79United States77.8-0.210Bahrain77.71.4

Where does contract law come in?

What is the relationship between promising and wealth?*

Where does contract law come in?

What is the relationship between promising and wealth?Between enforceable promises and wealth?*

Where does contract law come in?

What is the relationship between promising and wealth?Between enforceable promises and wealth?How about bare promises without contract enforcement?*

David HumeDoes the sanction provided by non-legal promissory institutions suffice?*Men being naturally selfish, or endow'd only with a confin'd generosity, they are not easily induc'd to perform any action for the interest of strangers, except with a view to some reciprocal advantage

*The possibility of defection destroys trustHobbes, Leviathan 14.18 (1651)

If a covenant be made wherein neither of the parties perform presently, but trust one another, in the condition of mere nature (which is a condition of war of every man against every man) upon any reasonable suspicion, it is void

For he that performeth first hath no assurance the other will perform after, because the bonds of words are too weak to bridle men's ambition, avarice, anger, and other passions, without the fear of some coercive power; which in the condition of mere nature, where all men are equal, and judges of the justness of their own fears, cannot possibly be supposed. And therefore he which performeth first doth but betray himself to his enemy.

*The Prisoners DilemmaUnderlies Hobbes Insight

A simple game that has become the dominant paradigm for social scientists since it was invented about 1960.

How the game works and why didnt it work for Dilbert

*The paradox of the PD gameWhile cooperation is collectively rational, defection is individually rational.

*The paradox of the PD gameWhile cooperation is collectively rational, defection is individually rational.

The undersupply of cooperation is the tragedy of the commons. Garrett Hardin, The Tragedy of the Commons (1968).

*Hollywood gets in the actRussell Crowe as John Nash in A Beautiful Mind

*The need for poetic license

*Modeling PD games

Game theoretic problems: payoffs for each player depend on actions of both

*Modeling PD games

Game theoretic problems: payoffs for each player depend on actions of both

Two possible strategies: A party cooperates when he performs value-increasing promises, and defects when he breaches

*Player 1Modeling Two-party choice

Cooperate

*Player 1Modeling Two-party choice

Defect

*Player 2Modeling Two-party choice: Player 2

Cooperate

*Player 2Modeling Two-party choicePlayer 2

Defect

*Player 2Player 1Modeling Two-party Choice Both Cooperate

CooperateDefectCooperateBoth cooperateDefect

*Player 2Player 1Modeling Two-party ChoiceBoth Defect

CooperateDefectCooperateDefectBoth defect

*Player 2Player 1Modeling Two-party ChoiceSuckers payoff for Player 1

CooperateDefectCooperatePlayer 1 cooperates, Player 2 defectsDefect

*Player 2Player 1Modeling Two-party ChoicePlayer 1s temptation to defect

CooperateDefectCooperateDefectPlayer 1 defects, Player 2 cooperates

*Player 2Player 1Bargains as a Prisoner Dilemma game Cooperation: Promise and PerformDefect: Promise and Breach

CooperateDefectCooperateJointcooperationPlayer 1: suckers payoffDefectPlayer 2: Suckers payoffJointdefection

*Player 2Player 1Plugging in payoffsFirst number is payoff for Player 1,Second number is payoff for Player 2

CooperateDefectCooperate3, 3-1, 4Defect4, -10, 0

*Player 1

What should Player 1 do if he knows Player 2 will cooperate?

CooperateCooperate3Defect4

*Player 1What should Player 1 do if he knows Player 2 will cooperate?

CooperateCooperate3Defect4

*Player 1

What should Player 1 do if he knows Player 2 will defect?

DefectCooperate-1Defect0

*Player 1What should Player 1 do if he knows Player 2 will defect?

DefectCooperate-1Defect0

*Player 1Defection dominates for Player 1

CooperateDefectCooperate3-1Defect40

*Player 2

What should Player 2 do if he knows Player 1 will cooperate?

CooperateDefectCooperate34Defect

*Player 2What should Player 2 do if he knows Player 1 will cooperate?

CooperateDefectCooperate34Defect

*Player 2What should Player 2 do if he knows Player 1 will defect?

CooperateDefectCooperateDefect-10

*Player 2What should Player 2 do if he knows Player 1 will defect?

CooperateDefectCooperateDefect-10

*Player 2Defection dominates for Player 2

CooperateDefectCooperate34Defect-10

*Player 2Defection dominates for both Players

CooperateDefectCooperateDefect0

*Player 2Player 1Modeling Two-party Choice

CooperateDefectCooperateBoth cooperatePlayer 1 cooperates, Player 2 defectsDefectPlayer 1 defects, Player 2 cooperatesBoth defect

*Joint Cooperation Everyone promises and performsIm worried about TessioThe food is better at the Tattaglias

*Joint defection Can these gentlemen be acting efficiently?An inefficient honor code

*Suckers payoff Sucker performs, other party defectsGONERIL Hear me, my lord; What need you five and twenty, ten, or five, To follow in a house where twice so many Have a command to tend you? REGAN What need one? KING LEAR O, reason not the need

*Defectors Payoff Defector breaches, sucker performsGov. Earl K. Long"Don't write anything you can phone. Don't phone anything you can talk. Don't talk anything you can whisper. Don't whisper anything you can smile. Don't smile anything you can nod. Don't nod anything you can wink."

"I can make them voting machines sing Home Sweet Home."

*Player 2Player 1Modeling Two-party Choice

CooperateDefectCooperateBoth cooperatePlayer 1 cooperates, Player 2 defectsDefectPlayer 1 defects, Player 2 cooperatesBoth defect

*PD games help to explain why we do dumb things

Over-fish lakes and oceans

Pollute

Arms race

Fail to exploit bargaining gains

*Joint DefectionThe Tragedy of the Commons and the Law of the Sea)

*How about promises without contract law?

You want to buy a 1956 Ford

*Promises without contract law

You want to buy a 1956 FordOf the remaining 1956 Fords, half are worth nothing (lemons) and the other half are worth $5000 (beauts)

*Promises without contract law

You want to buy a 1956 FordOf the remaining 1956 Fords, half are worth nothing (lemons) and the other half are worth $5000 (beauts)The seller tells you its a beaut.

*Promises without contract law

You want to buy a 1956 FordOf the remaining 1956 Fords, half are worth nothing (lemons) and the other half are worth $5000 (beauts)The seller knows which kind of car he has but you cant tell them apart

*Promises without contract lawOf the remaining 1956 Fords, half are worth nothing (lemons) and the other half are worth $5000 (beauts)The seller knows which kind of car he has but you cant tell them apartWhat would you pay for one?

*Promises without contract lawOf the remaining 1956 Fords, half are worth nothing (lemons) and the other half are worth $5000 (beauts)The seller knows which kind of car he has but you cant tell them apartThe trick: Sellers willingness to sell is a signalAkerlof, The Market for Lemons, 84 Q.J. Econ. 488 (1970)

*Promises without contract lawOf the remaining 1956 Fords, half are worth nothing (lemons) and the other half are worth $5000 (beauts)The seller knows which kind of car he has but you cant tell them apartQuestion: Is the seller satisfied with this result?

*Contract Law as a solution

Suppose that the defector is penalized through legal sanctions so that the incentive to defect disappears.

*What if contracts are prohibited?

*What if contracts are prohibited?Rembrandt, The Jewish Bride 1666Marriage is more than a contract; its a covenant

*What if contracts are prohibited?Rembrandt, The Jewish Bride 1666But its less than a contract if the parties have unilateral exit rights under no-faultdivorce laws

*Marriage, Divorce, Natality

What did no-fault divorce do to the cost of matrimonial fault?

*Marriage, Divorce, Natality

What did no-fault divorce do to the cost of matrimonial fault?Under fault, the straying party pays if he wants a divorceor if his spouse seeks oneSo fault is costly in a fault regime

*Marriage, Divorce, Natality

What did no-fault divorce do to the cost of matrimonial fault?

So how do you think no-fault divorce laws affected divorce levels? Bring and Buckley, 18 Int. Rev. Law & Econ. 325 (1998)

*Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce?

*Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce?Fewer marriages

*Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce?Fewer marriagesIncreased female participation in the labor force

*Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce?Fewer marriagesIncreased female participation in the labor forceIncreased human capital investments by women

*Marriage, Divorce, Natality How would you expect the parties to react to the increased probability of divorce?Fewer marriagesIncreased female participation in the labor forceIncreased human capital investments by womenAnd what about kids?

*Children as marriage-specific assetsDivorce rate 1965-83 Natality rate for married couples 1965-83

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*Absent legal barriers, will the parties always write a binding contract?The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs

*Absent legal barriers, will the parties always write a binding contract?The Coase Theorem: Parties will enter a binding contract to exploit all bargaining games unless prevented from doing so by transaction costs

So what are transaction costs?*Give examples of things that get in the way of bargaining

So what are transaction costs?*Too many parties? Eg, pollution

So what are transaction costs?*Emergencies? No time to bargain

So what are transaction costs?*Information processing problems?

*War as a Prisoners Dilemma ProblemSo why doesnt the Coase Theorem Work?Uccello, Battle of San Romano

*War as a Prisoners Dilemma ProblemThe Coase Theorem and Informational ProblemsIrwin McDowellFirst ManassasJuly 21, 1861

*War as a Prisoners Dilemma ProblemThe Absence of a Bargaining Space

*War as a Prisoners Dilemma ProblemAgent MisbehaviorSir Charles Napier:peccavi!

*All we are saying is Give Contracts a ChanceIranians employing the defect strategy

Is there no cooperation without binding contracts?*

Cooperation without Law?

Voting*

Cooperation without Law?

VotingNo littering*

Cooperation without Law?

Its 1998. There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, whoich hires editors. The other relies on individuals to submit entries for free*

Wikeconomics

Its 1998. There are two plans for an online dictionary. One is Encarta, promoted by Microsoft, which hires editors. The other relies on individuals to submit entries for free*

Open Source Software*Linux Mascot

Crowdsourcing*

Bloggers vs. Mainstream Media*

*George Mason School of Law

Contracts I

Bargaining Games

F.H. Buckleyfbuckley@gmu.edu

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