Spring 2012

January 23, 2012

4:20 p.m.

Russell Korobkin (UCLA)

The Borat Problem in Contract Law: Fraud, Assent, and Standard Forms

Abstract:
Two parties reach an oral agreement.  The first then presents a standard form contract, which the second signs without reading, or without reading carefully.  When the second party later objects that the first did not perform according to the oral representations, the first party points out that the signed document includes different terms or disclaims prior representations and promises.  I call this all-too-common occurrence the “Borat problem,” after litigation over the 2006 movie of that name based on this fact pattern.  

The Borat problem exists on the blurry border between tort and contract law.  This article describes the doctrinal indeterminacy and the underlying normative problem of bilateral opportunism that has caused courts to respond to the problem in a variety of inconsistent and unsatisfying ways.  It then makes the case that the costs of contracting can be minimized if parties who draft standard form contracts are required to obtain “specific assent” from their counterparts in order to contradict or disclaim prior representations, and non-drafting parties are required to satisfy a heightened evidentiary standard before being permitted to challenge the enforceability of standard form terms on the grounds of fraud or misrepresentation.  

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February 6, 2012
4:20 p.m.

Henry Hansmann (Yale)

Virtual Ownership and Managerial Distance: The Governance of Industrial Foundations
(with Steen Thomsen)

Abstract:
Industrial foundations are nonprofit holding companies that own business firms. These entities are common in Northern Europe, and many successful international companies are owned in thus fashion. Because of their strong economic performance and unusual combination of nonprofit and for-profit entities, they present interesting challenges to theories of the firm. In this paper, we present the first study of the manner in which the foundations govern the companies that they own. We work with a rich data set comprising 121 foundation-owned Danish companies over the period 2003-2008.

We focus in particular on a composite structural factor that we term "managerial distance."  We interpret this as a measure of the clarity and objectivity with which a foundation-owned company’s top managers are induced to focus on the company’s profitability.  More particularly, managerial distance seems best interpreted as a factor, or aggregate of component factors, that put the foundation board in the position of "virtual owners," in the sense that the information and decisions facing the managers are framed for them in roughly the way they would be framed for profit-seeking outside owners of the company.  Our empirical analysis shows a positive, significant, and robust association between managerial distance and company economic performance.  The findings appear to illuminate not just foundation governance, but corporate governance and fiduciary behavior more generally. 

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February 20, 2012
4:20 p.m.  Jerome Greene Annex

Florencia Marotta-Wurgler (NYU)

Does Contract Disclosure Matter?

Abstract:
Regulators often address the potential for one-sided standard form contracts by requiring extra disclosure of the terms. Despite its ubiquity, for a disclosure regime to be effective, it must increase readership of contracts beyond a nontrivial rate, and, in addition, individuals must be willing to change their decisions conditional on what they read. I follow the clickstream of 47,399 households to 81 Internet software retailers to test whether those who shop for software online are more likely to read the license agreement when it is more prominently disclosed. I find that the degree of disclosure has almost no impact on the rate at which consumers read license agreements. Moreover, those who do read are equally likely to purchase the software product regardless of the one-sidedness of the contract. The results suggest that mandating disclosure online is unlikely, on its own, to put pressure on sellers.

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March 5, 2012 
4:20 p.m.

George Triantis (Stanford) & Albert Choi (University of Virginia)

Bargaining Power and Contract Design

Abstract:
Over the past 40 years, an irrelevance proposition has been embraced implicitly in law-and-economics scholarship: bargaining power should affect only price and not non-price terms of a contract. This proposition is based on unstated assumptions that contracting is affected by neither transaction costs nor asymmetrical information and that the parties are risk neutral. In contrast, practitioners and commentators in industry regularly invoke bargaining power to explain static and dynamic patterns in non-price contract terms. The assumptions of the bargaining power irrelevance proposition, therefore, need to be unpacked and analyzed to bridge the gap between theory and the real world. In the first half of the paper, we identify and discuss a variety of explanations for the effect of bargaining power on contract design, under conditions of information asymmetry and positive transaction costs. These include the effects of shifts in market supply and demand and the effect of bargaining through lawyers. In the second half of the paper, we present an in-depth examination of one set of explanations, concerning the impact of bargaining power on screening and signaling incentives, when the value and cost of these terms vary across contracting parties, and when such values are private information. In the extreme cases in which one or the other party enjoys overwhelming bargaining power, the efforts of that party to capture a larger share of the surplus by screening or signaling may compromise the efficiency of the non-price terms. We show that this incentive disappears or is mitigated when bargaining power is more evenly shared between the parties: for example, when a monopolist faces the threat of a future entrant, when the parties can renegotiate, or when they are engaged in bilateral bargaining with even bargaining power. As a whole, the paper provides a theoretical basis for interpreting the intuition among market participants that the impact of bargaining power extends beyond price terms. Before concluding, we briefly suggest implications for legal policy, particularly the contract law doctrine of unconscionability.

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March 26, 2012 
4:20 p.m.

Scott Masten (Michigan)

On the Evolution of Collective Enforcement Institutions: Communities and Courts
(with Jens Prüfer)

Abstract:
Impersonal exchange has been a major driver of economic development.  But transactors with no stake in maintaining an ongoing relationship have little incentive to honor deals. Therefore, all economies have developed institutions to support honest trade and realize the gains of impersonal exchange.  We analyze the relative capacities of communities (or social networks) and courts to secure cooperation among heterogeneous, impersonal transactors. We find that communities and courts are complementary in the sense that they tend to support cooperation for different sets of transactions but that the existence of courts weakens the effectiveness of community enforcement. By relating the effectiveness of enforcement institutions to changes in the cost and risks of long-distance trade, driven in part by improvement in shipbuilding methods, our analysis also provides an explanation for the emergence of the medieval Law Merchant and its subsequent supersession by state courts. 

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April 9, 2012
4:20 p.m.

Joel Watson (UCSD) & Alan Schwartz (Yale)

Conceptualizing Contractual Interpretation

Abstract:
Contract interpretation is an important subject for lawyers but there are few rigorous economic analyses. We use a formal model to derive the interpretive rule that an “ideal” legal enforcer would adopt. Commercial parties make contracts to maximize gains from trade. Our enforcer is ideal, in the sense that he interprets contracts to maximize welfare over the set of contracting relationships. We then compare how actual interpretation matches the ideal. We derive the following results, among others: (a) An optimal interpretive rule induces parties to make efficient tradeoffs between the gain from accurate interpretation and the costs of (i) writing contracts; (ii) investing in the deal, which also conveys intent; and (iii) trials; (b) The optimal rule induces inefficient relationships not to form and permits the enforcer sometimes to exclude trial evidence and decide on reduced evidentiary bases; (c) Expertise in interpretation comes in several forms, including the ability to infer party intent from a performance and from the written words; (d) Parties choose between arbitrators and courts on the bases of their respective competencies and the cost of writing a contract meant for a court and the cost of writing a contract meant for an arbitrator; (e) Courts maximize accuracy in interpretation rather than welfare, which creates a number of inefficiencies; (f) Party attempts to constrain the evidence courts use would cause courts to act more as the ideal enforcer acts, so courts should obey party interpretive instructions. We also test several of the model’s predictions on a data set of almost 43,000 actual contracts. The data appear to be consistent with the theory.

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April 23, 2012 
4:20 p.m.

Ricard Gil (Johns Hopkins Carey Business School)

Does Vertical Integration Decrease Prices? 
Evidence from the Paramount Antitrust Case of 1948

Abstract:
I empirically examine the impact of the 1948 Paramount antitrust case on ticket prices using a unique data set collected from Variety magazine issues between 1945 and 1955. With weekly movie theater information on prices, revenues and theater ownership for an unbalanced panel of 393 theaters located in 26 different metropolitan areas, I find evidence consistent with Spengler’s (1950) prediction that vertical integration lowers prices through the elimination of double-marginalization. My results show that vertically integrated theaters charged lower prices and sold more admission tickets than nonvertically integrated theaters. I also find that the rate at which prices increased in theaters were slower before vertical separation than it was after separation. A back of the envelope calculation suggests that losses in consumer surplus due to the Supreme Court resolution and the corresponding sale of theater holdings by Paramount and seven other companies were sizable.

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