Optimally Vague Contracts and the Law

Nicola Gennaioli and Giacomo Ponzetto

No 10700, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Many real-world contracts contain vague clauses despite the enforcement risk they entail. 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; Imperfect enforcement; 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-cta and nep-law
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Optimally Vague Contracts and the Law (2017)
Working Paper: Optimally vague contracts and the law (2017)
Working Paper: Optimally Vague Contracts and the Law (2015)
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