EC516 Contracts and Organisations for Research Students: Lecture 4 - - PowerPoint PPT Presentation

EC516 Contracts and Organisations for Research Students: Lecture 4

Leonardo Felli LSE, D6 12 March 2009

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Benjamin Cardozo — 1921

“Law never is, but is always about to

• be. It is realized only when embodied

in a judgment, and in being realized,

• expires. There are no such things as

rules or principles: there are only isolated dooms. [...] [...] No doubt the ideal system, if it were attainable, would be a code at

• nce so flexible and so minute, as to

supply in advance for every conceivable situation the just and fitting rule. But life is too complex to bring the attainment of this ideal within the compass of human powers”.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Justinian — AD 529

1,392 years earlier — Justinian had quite a different idea of what the Law ought to be. The “Corpus Juris Civilis” in English translation adds up to 5,818 pages. Table VIII — Law VIII — Where a road runs in a straight line, it shall be eight feet, and where it curves, it shall be sixteen feet in width.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Code Napol´ eon — 1804

“By virtue of its simplicity, my one code was the source of more good in France than all the laws which preceded me.” (Bas-relief in Les Invalides, Paris.) The Code Napol´ eon (renamed the Civil Code) was promulgated in 1804. The Code Napoleon has served as the model for the codes of law of more than twenty nations.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Law of the Italian Republic — AD 2000

If the birth takes place during a railway trip, the declaration must be rendered to the railroad officer responsible for the train, who will draw a transcript of verbal declarations, as prescribed for birth certificates. Said railroad officer will hand over the transcript to the head of the railroad station where the train next stops. The head of such station will transmit the documents to the local registrar’s office to be appropriately recorded.

This is Article 40 of the regulations for registrar’s offices, issued as Decree Number 393 of November 3rd 2000 of the President of the Republic of Italy. Regulations issued to ensure the streamlining of procedures, as prescribed by Article 2, comma 12,

• f Law Number 15 of May 1997 of the Republic of Italy.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Motivation

There is a large empirical literature that shows that legal

• rigin matters (La Porta, Lopez-de-Silanes, Shleifer, and

Vishny 1997,1998, 1999, 2002, La Porta, Lopez-de-Silanes and Shleifer 2005, etc.) known as Law and Finance. We here model in a stylized way Case Law and Statute Law. We compare the two systems and provide conditions under which one legal system dominates the other.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Stylized differences between legal systems

Statute Law is a legislator-made Law: judges apply the statute. In the Case Law, there is (implicit) delegation of the law-making power to judges. In Case-law we have the rule of precedent (stare decisis), but not in Statute Law.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

A Big Caveat

Can we reinterpret this comparison in terms of Civil Law

• vs. Common Law?

To some extent, clearly yes (at least historically) ... but this is controversial (Hatfield, 2006, Whitman 2006). Common Law countries have accumulated a lot of statutes through time. In Civil Law judges have some leeway as well and precedents play some role (especially in Germany).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

The Question

Is the pragmatism of Case Law simply always superior to the rigidity of Statute Law? Are there universes in which Statute Law is instead superior? Or is it the case that the ascent of Case Law is like a scientific discovery? It just was not known before the 11th or 12th century, and those who discovered it and started using it became unambiguously better off.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law vs Statute Law: A First Answer

Premise: “[...] life is too complex [...]” Laws are bound to be Incomplete (impossible to fully describe/conceive ex-ante). Leaving things to the Courts is a way to delay the decisions to when more detailed information is available: ex-post. What are the Courts’ objectives? They are “ruling over

• thers” so we should be sure they have “social welfare” in

mind. If the Courts’ motives are “right” then the Case Law regime ought to be superior.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Punch-Line

We show that in some cases Statute Law is instead superior. This is because the Case Law advantage — ex-post decisions — may also be a disadvantage. Case Law Courts may suffer from time inconsistency (present bias) due to the timing of their decisions. In a dynamic framework this time-inconsistency problem is unavoidable. When cases are sufficiently homogeneous, the draw-backs

• f incompleteness (Statute Law) are outweighed by the

costs of time-inconsistency (Case Law).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Laws

With “fully contingent” (complete) Laws, “[...] a code at

• nce so flexible and so minute, as to supply in advance for

every conceivabe situation the just and fitting rule [...]” the Statute Law is clearly the ideal regime. “[...] But life is complex [...]” hence laws are not flexible, at least not as much as Courts decisions that occur after the fact and hence can depend on the details of the realized contingency. We model incomplete laws as fix rules that do not depend

• n the realized contingencies.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Time Inconsistent Courts: Examples

Patent policy: wide breadth is optimal ex ante to give incentives, but inefficient ex post. Investor Protection: ex ante borrowers are in favor of strong investor protection to have cheap credit, but not ex post. Long Sentences deters crime ex ante. Ex post, the deterrent effect does not play any role (three strikes you are out). Our model: Court’s decision may induce the parties to disclose their private information at the ex-ante stage (Anderlini, Felli, Postlewaite 2006).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Relation to ”Rules vs. Discretion” Literature

Statute Law is rule-based. Case Law is not a regime of full discretion; precedents sometimes bind. Precedents are a commitment device. Unlike Athey Atkeson Kehoe (2005), or Amador Angeletos Werning (2006)) the constraints on discretion (the precedents) arise endogenously and are not imposed by an external (optimal) mechanism designer.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Preliminaries

Infinite-period-lived Courts and sets of one-period-lived parties. Courts can either make a weak decision (W) or a tough decision (T ). Parties make private decisions based on the Court’s expected ruling (in equilibrium, perfect foresight). Two states of natures : the complex state C (with prob. ρ) and the simple state S (with prob. 1 − ρ).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Simple Environment S, probability (1 − ρ)

Π denotes Court’s ex-ante payoffs (social welfare), Π denotes Court’s ex-post payoffs. In environment S it is optimal for the Court to choose W ex-ante Π(S, T ) < Π(S, W) In environment S it is also optimal for the Court to choose W ex post:

• Π(S, T )

<

• Π(S, W)

Clearly in this environment there exists no time inconsistency.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Complex Environment C, probability ρ

In environment C it is optimal for the Court to commit ex-ante to choose T Π(C, T ) > Π(C, W) However, ex post, after private decisions have been made, it is optimal for the Court to choose W

• Π(C, T )

<

• Π(C, W)

This is the source of the Court’s time inconsistency. The present-bias temptation is therefore

• Π(C, W) −

Π(C, T ) > 0.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Setup

At the beginning of each period Nature:

determines whether the environment is C or S with probability ρ, 1 − ρ, in the Case Law regime draws ℓS and ℓC (more below)

The common discount factor of the Legislator and the Court is δ < 1 (chance that the same case occurs next period).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Statute Law

By incompleteness of laws, Statute Law can select a single ruling regardless of environment: either T or W. The optimal Statute Law solves: max

R∈{T ,W} (1 − δ) ∞

• t=0

δt [(1 − ρ)Π(S, R) + ρΠ(C, R)]

• r

max

R∈{T ,W} [(1 − ρ)Π(S, R) + ρΠ(C, R)]

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Proposition Choose W if S is more likely: ρ < ρ∗

SL.

Choose T if C is more likely: ρ > ρ∗

SL.

Where ρ∗

SL is such that:

(1 − ρ∗

SL) Π(S, W) + ρ∗ SL Π(C, W) =

= (1 − ρ∗

SL) Π(S, T ) + ρ∗ SL Π(C, T )

Denote the maximized welfare WSL(ρ).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Statute Law Welfare

WSL ρ 1 ρ∗

SL

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law: Preliminaries

Court can pick a different ruling in the two environments (S or C) unless it is constrained by precedents (stare decisis). Everyone (Parties and Court) knows whether precedents are binding or not. Precedents are a quadruple J = (τS, ωS, τC, ωC) satisfying the restrictions τS < ωS and τC < ωC. At the beginning of each period a random variable is realized: ℓS or ℓC, uniformly distributed over [0, 1]. The, say, C Court is free to choose if ℓC ∈ (τC, ωC). It is bound to W if ℓC ∈ [ωC, 1]. It is bound to T if ℓC ∈ [0, τC].

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law: Precedents

τC ωC 1 constrained to T constrained to W discretion

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law: Precedents (cont)

In each period — Case Law Court takes precedents J t as given and is either bound or not bound by them. The ruling of today’s (period t) Case Law Court, if it has discretion, affects the body of precedents for tomorrow’s (period t + 1) Case Law Court: J t+1. Each Case Law Court — if it has discretion — can also choose the breadth of its ruling bt ∈ {0, 1}.

Narrow Ruling bt = 0 ⇒ Small effect on precedents. Broad Ruling bt = 1 ⇒ Larger effects on precedents.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Assumptions on precedents technology

Assumption Case Law Court always has discretion: ωt

S −τ t S > 0, ωt C −τ t C > 0 ⇒ ωt+1 S

−τ t+1

S

> 0, ωt+1

C

−τ t+1

C

> 0. Assumption Case Law Courts can choose rulings that have no effect on precedents (zero breadth). bt = 0 ⇒ J t = J t+1 (Restrict the holding to the facts of the case). “Our consideration is limited to the present circumstances, for the problem of equal protection in election processes generally presents many complexities.” Bush v. Gore (00-949). US Supreme

Court Per Curiam

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law: Judge’s Problem

Case Law Court’s problem if it has discretion: max

Rt∈{T ,W},bt∈[0,1](1−δ)

Π(Et, Rt) + δ

• Zt+1(J t+1(J t, bt), σ, ρ)
• Lemma

Expected welfare in Case Law is weakly monotonically increasing. Case Law evolves for the better (thanks to zero breadth) (Posner 1973, Rubin 1977).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Evolving Case Law

Proposition (Evolving and Mature Case Law) Fix any J 0 and consider any realized path of the Case Law equilibrium environment. Then there exists an integer m, which in general depends on J 0, such that: Along any such path the Court will rule T in environment C when it has discretion for a total of at most m times. After a finite number of periods the Case Law Court when in C reverts to take the weak decision W whenever it has discretion: the Case Law matures and stops evolving.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law Evolution: Intuition

Under Case Law, the Court wants to take the time inconsistent decision (W) if it looks only at today’s case. If it looks forward, via precedents, it wants to take the “right” decision (T in environment C). The effect it can have via precedents is marginal. What matters is the change in the body of precedents. The present-bias temptation is equal to the difference

• Π(C, W) −

Π(C, T ) > 0 (does not changes through time). Therefore, when the marginal effect becomes ”small” (DRS and monotonicity), the Case Law will stop “evolving.”. At some point all Case Law Courts with discretion choose the time-inconsistent decision W and zero breadth.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Statute Law vs. Case Law

Proposition (Statute Law Dominance) The Statute Law regime yields higher equilibrium welfare than the Case Law regime for high values of ρ. More specifically, let any J 0 be given. Then there exists a ρ∗

CL

∈ (0, 1) such that for every ρ ∈ (ρ∗

CL, 1] we have that

WSL(ρ) > WCL(J 0, ρ). where WCL(J 0, ρ) is expected welfare under the Case Law regime, given J 0 and ρ. In general, ρ∗

CL depends on J 0.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Statute Law vs. Case Law: Intuition

The dominance of Statute Law is due to the lack of evolution of the Case Law. Eventually, Courts that have discretion take the present-biased decision (W). This stops the evolution of case law implying that the parties’ welfare under case law is bounded away from the first best welfare. Clearly, time consistency problems have bite when the environment is C. This happens a fraction ρ of the times. When the environment is very often of either one type or the other the “lack of flexibility” of Statute Law matters less. Hence, for ρ sufficiently close to one the Statute Law dominates, since under the Statute Law the Court is committed to choose T with probability one.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Welfare under Statute Law and Case Law.

ρ 1 ρ∗

SL

✻ ✲

¯ ρ W WSL = WCL WSL WCL

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Statute Law Dominance

Statute Law Dominance is a very general result, for any precedent technology that satisfies our assumptions. What about around ρ = 0? Statute Law achieves first best; Case Law courts have no incentive to make ”bad” decisions... ...but welfare in Case Law depends on initial condition. If τ 0

S > 0 then Statute Law is likely to dominate as well.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Well Behaved Precedent Technology

Assume that: the precedent technology—the cutoffs τE(τ, ωR, 1) and ωE(τ, ω, R, 1)—are monotonic (continuous) in τ and ω, respectively, in both states E ∈ {S, C}; the precedent technology satisfies “no cross-state effects,” e.g. at t if the state is C then τ t

S = τ t+1 S

and ωt

S = ωt+1 S

; the precedent technology satisfies “reversibility,” e.g. if at t a Court takes decision (T , b = 1) and at t + 1 decision (W, b = 1) then τ t

E = τ t+2 E

, ωt

E = ωt+2 E

; the cutoff τC(τ, ω, R, 1) satisfies DRS in τ and “independent impact” from ω; the cutoffs τ t

S and ωt C have “no interior asymptotes.”

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

How Does the Equilibrium Look like in state S?

We construct a Markov Perfect equilibrium (with state variable J t). If τ 0

S = 0 then the Court takes decision W whether it has

discretion or not, the breath b is indeterminate. If instead τ 0

S > 0 the optimal choice for the Court is to

take the decision (W, b = 1) until τS = 0 after that the Court takes decision W for ever on, however b is indeterminate. In either case the steady-state Court’s decision is W.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

How Does the Equilibrium Look like in state C?

Suppose first τ 0

C = 0 and ω0 C = 1.

A similar characterization applies to a general (τ 0

C, ω0 C).

Notice first that the Court’s decision (W, bt = 1) is strictly dominated. We can focus on the two Court’s decisions: (T , bt = 1) (W, bt = 0).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

There exist a unique threshold ¯ τ such that the Court is indifferent between the two decisions above: (1−δ)[ Π(W)− Π(T )] = ρ δ[τC(¯ τ, T , 1)−¯ τ] [Π(T )−Π(W)] When (τ t

C > ¯

τ), precedents do not move, (W, bt = 0), the system is in steady state. When (τ t

C < ¯

τ), precedents move (they improve) towards a steady state, (T , bt = 1). The Markov perfect equilibrium cannot be in pure

• strategies. If there exist a last period in which the Court

chooses T and b = 1 procrastination is a profitable deviation for the Court.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Proposition (Equilibrium Characterization) There exists a Markov perfect equilibrium in mixed strategies in which the Court is indifferent at any t such that τ t

C < ¯

τ. In this case the Court randomizes with probability pt between (T , bt = 1) (evolution of precedents) and (W, bt = 0) (no evolution). At any t such that τ t

C > ¯

τ the Court chooses (W, bt = 0)(steady state). We interpret randomizing Court as a situation in which the body of precedents is ambiguous (incentives to transact and go to Court).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

τC 1 τ 0

C

s ❯ ❄

• τ

¯ τ steady state discretion

❃

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Case Law Dominance

What about Case Law Dominance? A candidate interval where we expect Case Law Dominance is around ρ = ρ∗

SL.

The Statute Law legislators are indifferent between W or T . The Parties’ expected welfare is WSL(ρ∗

SL) = ρ∗ SL Π(C, W) + (1 − ρ∗ SL)Π(S, W)

Consider Case Law and assume τ 0 = 0 and ω0 = 1 in both states S and C. In state S Common Law Courts will always take decision W.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

In state C let τ be the steady state cutoff, τ ≥ ¯ τ. The Parties’ steady state expected welfare in Common Law WCL(J 0, ρ∗

SL) is:

ρ∗

SL [

τ Π(C, T ) + (1 − τ)Π(C, W)] + (1 − ρ∗

SL)Π(S, W)

Clearly: [ τ Π(C, T ) + (1 − τ)Π(C, W)] > Π(C, W) Proposition (Case Law Dominance) Case Law dominates Statute Law in a neighborhood of ρ∗

SL,

(for δ high enough): WSL(ρ∗

SL) < WCL(J 0, ρ∗ SL).

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Some Evidence...

Niblett, Posner, and Shleifer (2008) investigate the application of the ”Economic Loss Rule” (ELR) in 465 appellate decisions over 35 years. Economic Loss Rule implies that one cannot sue in tort for “economic loss” unless that loss is accompanied by personal injury or property damage (with standard exceptions, fraud). ”Tort law is a superfluous and inapt tool for resolving purely commercial disputes. We have a body of law designed for such disputes. It is called contract law.” (902 F.2d 573, 574 , 7th Cir. 1990). ELR encourages parties to solve their potential problems through contracts. It is widely recognized as the (ex-ante) efficient rule.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

However, ex-post the judge may have sympathy for wronged plaintiffs (for ex. because warranty has expired) and make exceptions to the ELR. The initial twenty years after the Seely decision are best described as years of growing acceptance of the ELR. In the final decade of the sample, however, courts moved away from strict application of the ELR and invoked more and more idiosyncratic exceptions.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Percentage of Tort wins across states

.2 .4 .6 .8 1 % of cases 1970 1980 1990 2000 2010 Year California Florida Illinois New York Ohio

Figure 5.3: Tortwin over time in the five states with the highest caseloads

Unlike the overall tortwin pattern, the proportion of cases that apply exceptions

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Justinian

The Appian Way was built approximately in 300 BC and was fully replaced 2,084 years later in AD 1784. A “slow changing” environment: a very high (or very low) ρ above. The Statute Law regime is likely to be superior.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Cardozo

Edison’s “improved” stock ticker was introduced in 1871, the last mechanical stock ticker was introduced in 1960, the wireless device in 1996. A fast changing environment: intermediate values, ρ = ρ∗

• SL. (La Porta et al, Law and Finance — but Rajan

and Zingales 2003 and Lamoreaux and Rosenthal 2005.). Statute Law is likely to be inferior because of its lack of flexibility.

EC516 Contracts and Organisations for Research Students: Lecture 4 Leonardo Felli Civil Law vs. Common Law

Motivation Ingredients

The Model

The Economy Infinite Period Dynamic Game Observations

The Evolution

• f Case Law

Moral(s) of the Story

Cardozo: pessimism

Cardozo was also pessimistic “[...] there are only isolated dooms.” In our framework, this statement can be reinterpreted as: Case Law is “doomed” to become mature, and after maturing to succumb to the time-inconsistency problem. Case Law improves through time (zero breadth), but it does not reach full

• ptimality (Posner, 1973, 1990, 2003,

Rubin 1977, Gennaioli and Shleifer 2005).