University of Virginia Legal Working Paper Series
University of Virginia John M. Olin Program in Law and Economics Working Paper Series
Completing Contracts in the Shadow of Costly Verification
Abstract
Contract theory typically holds that verification costs are obstacles to complete contracting; yet, real world contracts often contain provisions that seem costly to verify. We show how a costly signal can play an important role in contracts. Verification (or litigation) costs operate as a screen on the promisee’s incentive to sue and as a sanction against the breaching party. So long as the court’s judgment is correlated with the realized state of the world, therefore, the parties can design a set of prices (including damages) so as to provide additional incentive to the promisor through an off-the-equilibrium, credible litigation threat. We show that contract parties may prefer to adopt a costly signal over a costless signal. Rather than focusing solely on either the problems of adjudication or those of contracting (without sufficient regard to how the disputes will be resolved in the future), we have attempted to take a more comprehensive approach by looking at the design of contracts in anticipation of the path of the adjudication process
Subject Area
Contracts, Corporations, Courts, Criminal Law and Procedure, Dispute Resolution, Domestic Relations, Economics, Education Law, Elder Law, Employment Practice, Energy and Utilities Law, Environmental Law, Estate Planning and Probate, Evidence, Food and Drug Law, General Law, Government Contracts, Health Law and Policy, Housing Law, Human Rights Law, Immigration Law, Indian Law, Insurance Law, Intellectual Property Law, International Law, International Trade, Judges, Jurisdiction, Jurisprudence, Juveniles, Labor Law, Land Use Planning, Law and Economics
Recommended Citation
Albert H. Choi and George Triantis,
"Completing Contracts in the Shadow of Costly Verification"
(June 2007).
University of Virginia Legal Working Paper Series.
University of Virginia John M. Olin Program in Law and Economics Working Paper Series.
Working Paper 34.
http://law.bepress.com/uvalwps/olin/art34
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