A Characterisation of verifiability and observability in contracts

Reference to the notions of verifiability and observability is widespread in contract theory. This paper is a contribution towards a formalization, and related characterizations, of these two notions. In particular we first define them, through knowledge operators, and then provide characterization results in terms of the relevant state spaces. Since, when referring to a contract, observability typically pertains to parties while verifiability to the court, we define them differently. A main finding of the paper is that for proper contract verifiability to obtain the court must imagine true states and have information processing abilities as good as the parties

Optimal Procurement of a Credence Good Under Limited Liability

This paper analyzes the optimal contract for a consumer to procure a credence good from an expert when (i) the expert might misrepresent his private information about the consumer’s need, (ii) the expert might not choose the requested service since his choice of treatment is non-observable, and (iii) limited liability of the expert precludes imposing penalty payments on him. We characterize payments under the optimal contract and show that, compared with the first-best, these induce inefficient undertreatment. We further show that separating diagnosis and treatment increases consumer surplus. Whether it decreases or increases the likelihood of undertreatment, however, depends on the accuracy of the expert’s information

Renegotiation and the Form of Efficient Contracts

Two parties may agree to a mutually binding contract that will govern their behavior after an uncertain event becomes known. As there is no agent who can both observe this uncertain outcome and enforce the contract, contingent agreements are precluded. However, the parties recognize that the uncertain event will be common knowledge for them, and that they will be able to renegotiate the contract voluntarily, provided that they both gain in doing so. When structuring the original contract they can foresee this renegotiation phase. Efficient contracts are those that perform best, when taking this into account. This paper studies the form of such efficient contracts. It is shown that it is always better to have a contract than it is to have none, no matter which party has the preponderence of bargaining strength in the renegotiation phase. We also study whether renegotiation can substitute completely for the absence of contingent contracts. We characterize a family of cases where it can. And we present some "second-best" results in others, where it cannot

The Problem of Creative Collaboration

In this Article, we explore a central problem facing creative industries: how to organize collaborative creative production. We argue that informal rules are a significant and pervasive—but nonetheless underappreciated—tool for solving the problem. While existing literature has focused on how informal rules sustain incentives for producing creative work, we demonstrate how such rules can facilitate and organize collaboration in the creative space. We also suggest that informal rules can be a better fit for creative organization than formal law. On the one side, unique features of creativity, especially high uncertainty and low verifiability, lead to organizational challenges that formal law cannot easily address, as demonstrated by recent high profile cases like Garcia v. Google, Inc. On the other side, certain informal rules can meet these challenges and facilitate organization. These informal rules, functioning through mechanisms like reputation and trust, can sustain organizational solutions without a manager, a hierarchical firm, or formal allocation of control rights. In addition to showing how informal rules can work without (much) formal law, we also sketch out the dynamics involved in more complex cases where informal rules function alongside formal law in organizing collaborative creativity

The Economics of Credence Goods: On the Role of Liability, Verifiability, Reputation and Competition

Credence goods markets are characterized by asymmetric information between sellers and consumers that may give rise to inefficiencies, such as under- and overtreatment or market break-down. We study in a large experiment with 936 participants the determinants for efficiency in credence goods markets. While theory predicts that either liability or verifiability yields efficiency, we find that liability has a crucial, but verifiability only a minor effect. Allowing sellers to build up reputation has little influence, as predicted. Seller competition drives down prices and yields maximal trade, but does not lead to higher efficiency as long as liability is violated.

The Economics of Credence Goods: On the Role of Liability, Verifiability, Reputation and Competition

Credence goods markets are characterized by asymmetric information between sellers and consumers that may give rise to inefficiencies, such as under- and overtreatment or market break-down. We study in a large experiment with 936 participants the determinants for efficiency in credence goods markets. While theory predicts that either liability or verifiability yields efficiency, we find that liability has a crucial, but verifiability only a minor effect. Allowing sellers to build up reputation has little influence, as predicted. Seller competition drives down prices and yields maximal trade, but does not lead to higher efficiency as long as liability is violated.competition, reputation, verifiability, liability, experiment, credence goods

Ownership structure and efficiency: An incentive mechanism approach

Corporate Performance;Corporate Ownership

Taxonomy for Justifying Legal Intervention In An Imperfect World: What To Do When Parties Have Not Achieved Bargains Or Have Drafted Incomplete Contracts

This paper addresses the fundamental methodological issue of when courts should intervene in incomplete contracts by interpreting them, filling in gaps and imposing liability on parties who have not yet reached a bargain. It addresses whether such intervention poses a threat to the parties\u27 freedom from contract, the subject of the Wisconsin Symposium on Freedom from Contract. It uses an instrumental approach to determine the circumstances in which courts can outperform parties in improving welfare by intervention. It assesses the two dominant strands of scholarship for addressing the legal intervention question. One strand emphasizes the costs of parties achieving complete contracts and justified legal intervention as a means to reduce such transaction costs. The other strand of scholarship, represented by the new formalists, emphasizes the difficulty of supplying terms that depend on unverifiable or unobservable information. While both strands of the literature contain valid insights, this paper suggests that neither strand of scholarship provides an analysis of how intervention would advance or hinder the parties\u27 welfare when certain factors such as uncertainty, sunk costs and opportunism are taken into account. Therefore, they cannot assess whether intervention in the form of a precontractual liability rule, with its apparent reduction in freedom from contract, advances welfare or not. This paper develops a taxonomy for legal intervention that focuses on the structural barriers that interfere with the parties\u27 ability to solve a key problem in contracting: the tendency of parties to behave opportunistically. To date, the full implications of this behavioral uncertainty have not been sufficiently incorporated into models assessing legal intervention nor into models demarcating the appropriate boundaries realm for freedom from contract. This paper suggests that legal intervention may be called for when sunk costs and uncertainty about the likelihood of opportunistic behavior are present and the parties\u27 costs of dealing with the recurring problem on their own are most costly than judicial intervention. It specifically explores the taxonomy of legal intervention in the specific context of precontractual liability and the implied limits on revocation in Drennan and unilateral contracts