Why Do We Know What We Know? Reevaluating the Economic Case against Pre-Contractual Disclosure Duties and for Break-Up Fees
The economic analysis of contract law offers influential arguments against pre-contractual disclosure duties and for break-up fees, based on the presumption that pre-contractual duties are (or should be) set to provide sufficient incentives to optimally invest in acquiring information at the negotiation stage. We suggest, however, that the existing analysis is flawed, since it overlooks an important incentive for investing in information gathering.
According to the conventional wisdom, a negotiating party will be motivated to invest resources in information gathering only on the basis of its expectation to extract the contractual surplus that the investment may generate. As a result, it is arguably essential to protect the investing party’s ability to benefit from its investment (by allowing non-disclosure) or to strengthen its bargaining position by guaranteeing reimbursement for the investment (break-up fees). However, contracting parties (e.g., the purchaser) invest resources in acquiring information not only—and probably not even primarily—to strengthen its bargaining position vis-à-vis its counterpart (e.g., the seller). Rather, the investment in acquiring information is often aimed at achieving an advantage vis-à-vis its competitors (e.g., other potential purchasers of the same asset), endeavoring to increase the investing party’s likelihood of forming a contract. Thus, even if the seller is able to extract all the contractual surplus generated by the investment, potential purchasers may well find it beneficial to invest in acquiring information to gain a competitive edge toward sealing a deal. In layman’s terms: a negotiator may invest in gathering information not only for the hope of sweetening the deal for herself, but also for the prospect of being able to submit a better offer to the other party.
As a result, the argument of the existing literature against imposing a duty to disclose information and in favor of reimbursement provisions cannot be substantiated without a careful inquiry into competition-based motivations to gather information. Specifically, the analysis yields that, among other things, the exemption from disclosure cannot be justified on efficiency grounds in case of information that players in the relevant market regularly collect (e.g., examining the property that is offered for sale or interviewing potential job candidates). The competition-based motivation is insufficient, and legal protection is justified, only in the case of “exceptional” deliberately acquired information (e.g., searching for oil reserves or conducting a thorough job-screening through an extensive training program).
Contracts | Law and Economics
Date of this Version
Barak Medina and Ofer Grosskopf, "Why Do We Know What We Know? Reevaluating the Economic Case against Pre-Contractual Disclosure Duties and for Break-Up Fees" (August 25, 2006). bepress Legal Series. bepress Legal Series.Working Paper 1626.