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Contract Innovation and Legal Evolution under Imperfect Enforcement

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  • Nicola Gennaioli
  • Giacomo A. M. Ponzetto

Abstract

We model the joint evolution of contracts and precedents by introducing imperfect enforcement into a standard incomplete contracts setup. We assume that biased trial courts can refuse to verify novel evidence but are bound to respect precedents, namely to verify evidence that other judges verified in past cases. We find that optimal contracts are innovative (contingent on both precedents and novel evidence), but noisy evidence and judicial biases introduce enforcement risk and cause incentives to be low-powered. Litigation of innovative contracts refines the law, making it more informative. This evolution improves enforcement and makes contracts more complete, thereby enabling higher-powered incentives and improving welfare. This beneficial mechanism is hampered by judicial bias, which slows down legal evolution and causes enforcement risk to persist for a long time.

Suggested Citation

  • Nicola Gennaioli & Giacomo A. M. Ponzetto, 2015. "Contract Innovation and Legal Evolution under Imperfect Enforcement," Working Papers 836, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:836
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    References listed on IDEAS

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    Cited by:

    1. Anderlini, Luca & Felli, Leonardo & Riboni, Alessandro, 2020. "Legal efficiency and consistency," European Economic Review, Elsevier, vol. 121(C).

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    More about this item

    Keywords

    contracts; imperfect enforcement; legal evolution; precedents;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General
    • K41 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Litigation Process

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