Spring 2004 Workshops
Law and Economic Studies
January 12, 2004
William Bentley MacLeod, Visiting Professor of Economics, Princeton University
and Professor of Economics and Law, University of Southern California
On the Efficiency and Enforcement of Stndard Form Contracts -
The Case of Construction
Authored with Surajeet Chakravorty
Abstract - Most contracts are not written from scratch but depend upon forms and terms that have been successful in the past. In this paper we study the structure of the form construction contracts published by the American Institute of Architects. We show that these contracts are an efficient solution to problem of procuring large complex projects when unforseen events are inevitable. The optimal mechanism corresponding to the AIA contract is consistent with decisions of the courts in several prominent, but controversial cases, and provides an economic foundation for a number of the common law excuses from performance.
MacLeod, W. Bentley - Spring 04.pdf
February 2, 2004
Christopher S. Yoo, Vanderderbilt University Law School
Copyright and Product Differentiation
Abstract - Existing economic analyses generally frame copyright as presenting a conflict between promoting efficient levels of access to creative works and providing sufficient incentives to support their creation. The supposed irreconcilability of the access-incentives tradeoff has led most scholars to regard copyright as a necessary evil and to advocate limiting copyright protection to the lowest level still sufficient to support creation of the work. In this Article, Professor Christopher Yoo breaks with the conventional wisdom and proposes a new approach to copyright law based on the economics of product differentiation. Not only does the differentiated products approach provide a better account for many features of real-world markets for creative works. It also demonstrates that the access-incentives tradeoff may not be as irreconcilable as generally believed. Both considerations can be promoted simultaneously through facilitating entry by close substitutes for existing works. Equally importantly, rather than representing the strength of copyright protection with a single variable in the manner of previous analyses, the differentiated products approach makes it possible to isolate the impact of three different aspects of copyright protection. This allows for a more nuanced analysis which suggests that economic welfare would best be promoted if copyright were strengthened along two of these dimensions and weakened along the third.
Yoo, Christopher S. - Spring 04
February 16, 2004
Robert H. Sitkoff, Northwestern University School of Law
Visiting University of Michigan Law School
An Agency Costs Theory of Trust Law
Abstract - This Article develops an agency costs theory of the law of private trusts, focusing chiefly on donative trusts. The agency costs approach offers fresh insights into recurring problems in trust law including, among others, modification and termination, settlor standing, fiduciary litigation, trust-investment law and the duty of impartiality, trustee removal, the role of so-called trust protectors, and spendthrift trusts. The normative claim is that the law should minimize the agency costs inherent in locating managerial authority with the trustee and the residual claim with the beneficiaries, but only to the extent that doing so is consistent with the ex ante instructions of the settlor. Accordingly, the use of the private trust triggers a temporal agency problem (whether the trustee will remain loyal to the settlor's original wishes) in addition to the usual agency problem that arises when risk-bearing and management are separated (whether the trustee/manager will act in the best interests of the beneficiaries/residual claimants). The positive claim is that, at least with respect to traditional doctrines, the law conforms to the suggested normative approach. This Article draws on the economics of the principal-agent problem and the theory of the firm, and it engages the ongoing debate about whether trust law is closer to property law or contract law. Although the analysis focuses on donative trusts, it should be amenable to extension in future work to commercial and charitable trusts.
Sitkoff, Robert H. - Spring 04.pdf
March 1, 2004
Lee Anne Fennell, University of Tesxas School of Law
Common Interest Tragedies
Abstract - This paper engages one of the fastest-growing topics in property theory, the anticommons. The anticommons idea originated in Frank Michelman's description of a regulatory regime in which nobody could use a particular resource without the permission of everyone else. Michael Heller's subsequent construction of a category of "anticommons property" corresponding to recognizable resource problems sparked a surge of scholarly interest in the notion. The anticommons template has now been applied in many property contexts, from patents to land use. However, some of the key criteria scholars have offered for identifying an anticommons and distinguishing it from an ordinary commons collapse upon scrutiny. The fragility of the existing boundaries between commons and anticommons points to a larger question that takes center stage here: How might the universe of common and interdependent resource problems be most usefully carved up?
In addressing that question, the paper makes three contributions. First, it develops a functional taxonomy for categorizing common interest tragedies. This taxonomy breaks tragedies into categories at the macro level based on the pattern of strategic interaction they embody, and further differentiates among tragedies at the micro level based on the shape of the production function for the resulting surplus or deficit. Second, the paper explores underappreciated connections between types of resource-related dilemmas, and highlights the choices that often must be made between two potential tragedies in complex, interdependent settings. Third, the paper shows how the taxonomy developed here offers access to analytic tools for making such choices. The approach taken here is therefore designed to provide greater analytical traction on resource allocation problems, as well as to advance dialogue in this area of property theory.
Fennell, Lee Ann - Spring 04.pdf
March 22, 2004
Henry Hansmann, New York University, School of Law
Legal Entities, Asset Partitioning, and The Evolution of Organizations
Authored with Reinier Kraakman, and Richard Squire
Abstract - Economic activity in modern market economies is dominated, not by individuals, but by organizations. Most prominent among those organizations are private business firms that own assets, contract, and incur liabilities as economic actors distinct from their owners and managers. Firms of this character are, in historical terms, a relatively recent phenomenon, dating principally from the late 17th century. If we look back further than that, we find not just that such firms were largely absent, but that the basic legal framework for forming them was lacking as well. In this essay we analyze, in economic terms, the evolution of that legal framework from Roman times to the present, and explore its relationship to the development of both commercial and noncommercial organizations. Our object is not simply to understand the past, but also to shed light on the modern state of organizational structure and organizational law, and on their likely future development.
Previous work in economic and legal history has focused heavily on limited liability as the most important legal innovation in the development of commercial firms. In explaining the emergence of limited liability, moreover, current literature focuses on the demand side. The industrial revolution, it is argued, brought productive technology requiring large amounts of capital that had to be assembled from multiple investors, and legal forms suited to raising that capital were therefore devised. This story, we believe, is highly incomplete. Of greater importance than limited liability, arguably, is the reverse rule, which shields the assets of the firm from creditors of the firm's owners. Unlike limited liability, this rule -- which we have elsewhere termed "affirmative asset partitioning," and which we here call simply "entity shielding" -- is universal in modern organizational forms, and is strongly dependent on law to be workable. Yet entity shielding appears only relatively recently in commercial enterprise. In explaining this fact, we focus not on the demand side, but on the supply side. If it is to be beneficial on net, entity shielding requires that a firm's creditors and owners have the practical ability to demarcate and police the boundary between the firm's assets and the assets of the firm's owners. Not surprisingly, therefore, we find that the first commercial firms formed as distinct entities were of a character that made those boundary problems relatively tractable. A variety of legal and practical innovations have made the firm/owner boundary easier to patrol in recent centuries, permitting the increasingly widespread proliferation of commercial firms organized as distinct entities.
While our principal focus is on commercial enterprise, our analysis also sheds light on the development of noncommercial entities, including the state, the family, and nonprofit organizations.
Hansmann, Henry - Spring 04.pdf
April 19, 2004
Robert E. Scott, University of Virgiunia School of Law
Embedded Options and the Case Against Compensation in Contract Law
Authored with George G. Triantis
Abstract - Compensation is the governing principle in contract law remedies. The principle shapes the doctrines that specify the consequences of breach: particularly the default provision for expectation damages and the restriction on the parties' ability to stipulate damages. Yet, the compensation principle has tenuous historical, economic and empirical support. Moreover, a promisor's right to breach is a subset of a family of termination rights that serve important risk management functions. The termination rights, in turn, can be characterized as call options on the subject matter of the contract. Where a buyer can terminate her obligation to purchase a good, she effectively holds a call option defined by an option price and an exercise price. The option price is the buyer's sunk investment, which may be in the form of the prospective damages liability or termination fee under the contract, and the exercise price is the additional sum needed to acquire the good. In this article, we analyze a variety of factors that determine the choice with respect to any given exchange among the many available pairs of option price and exercise price. Sellers often sell insurance to their buyers in the form of these embedded options. We explain why compensation is of little relevance to the option price agreed to by the parties. We propose a novel explanation for penalty liquidated damages and thereby contribute to the academic criticism of the penalty rule restriction on liquidated damages. Moreover, in light of the heterogeneity among optimal option prices, we also make the case against having an expectation damages default rule to begin with. In thick markets, we argue for enforcing the parties ex ante risk allocation with market damages. In thin markets, we propose that parties be induced to agree explicitly with respect to all termination rights, including breach damages, either by the threat of specific performance of their contemplated exchange or, in the case of consumers, by a default rule that provides them a termination option at no cost.
Scott, Robert E. - Spring 04.pdf