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Optimally Vague Contracts and the Law

Giacomo Ponzetto and Nicola Gennaioli
Authors registered in the RePEc Author Service: Enrico Perotti (e.c.perotti@uva.nl)

No 747, Working Papers from Barcelona School of Economics

Abstract: Many real-world contracts contain vague clauses despite the enforcement risk they en- tail. To study the causes and consequences of this phenomenon, we build a principal-agent model in which contracts can include vague clauses whose enforcement may be distorted by opportunistic litigants and biased judges. We find three results. First, the optimal contract is vague, even if courts are very imperfect. Second, the use of vague clauses is a public good: it promotes the evolution of precedents, so future contracts become more complete, incentives higher powered, and surplus larger. Third, as precedents evolve, vague contracts spread from sophisticated to unsophisticated parties, expanding market size. Our model sheds light on the evolution and diffusion of business-format franchising and equity finance

Keywords: contracts; contract enforcement; optimal contracts; legal evolution; precedents (search for similar items in EconPapers)
JEL-codes: D86 K12 K40 (search for similar items in EconPapers)
Date: 2015-07
New Economics Papers: this item is included in nep-law and nep-mic
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Related works:
Working Paper: Optimally Vague Contracts and the Law (2017) Downloads
Working Paper: Optimally vague contracts and the law (2017) Downloads
Working Paper: Optimally Vague Contracts and the Law (2015) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:bge:wpaper:747

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