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Optimal Contracts with Enforcement Risk

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  • Gennaioli, Nicola

Abstract

I build a model where potentially biased judges verify complex states by interpreting an imperfect signal whose noise captures factual ambiguities. In a sales and a financial transaction I show that judicial biases amplify and distort factual ambiguities, creating enforcement risk. To insure against such risk, parties write simple non-contingent contracts that optimally protect the party that is most vulnerable to judicial error. These results shed light on the empirical association between law and finance and rationalize salient features of real world enforcement regimes.

Suggested Citation

  • Gennaioli, Nicola, 2011. "Optimal Contracts with Enforcement Risk," CEPR Discussion Papers 8405, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:8405
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    Keywords

    Imperfect judicial enforcement; Optimal contracts;

    JEL classification:

    • K00 - Law and Economics - - General - - - General (including Data Sources and Description)

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