Plaintiffs and defendants are unrealistically optimistic with regard to the probability of prevai... more Plaintiffs and defendants are unrealistically optimistic with regard to the probability of prevailing at trial. This systematic bias is well documented, and has been often invoked to explain breakdowns in pre-trial settlement negotiations. How can a systematic bias towards optimism prevail in a competitive world, which usually punishes inaccurate assessments of reality ? The systematic optimism of lawyers is even more of a puzzle. A lawyer suffering from a persistent problem of inaccurate assessments will surely be driven out of the market. The present analysis challenges these conventional allegations. Using evolutionary game theory, we demonstrate that "market pressure", or an alternative imitation process, favor cautiously optimistic litigants. The pre-trial environment, inspired by the legal system, fosters optimism through the mechanism of settlement negotiations. We study a dynamic model, which allows us to derive the evolutionary stable level of optimism, under different legal regimes. Our analysis emphasizes the major role of the prevailing legal rule in determining the equilibrium level of optimism. By doing so we hope to shed new light on the ongoing debate regarding the effects of legal rules on the probability of settlement. Specifically, the evolutionary analysis qualifies the classical argument, that the American rule is superior to the British fee-shifting rule in fostering settlements.
This Essay studies bundling of two (or more) products as a strategic response to consumer misperc... more This Essay studies bundling of two (or more) products as a strategic response to consumer misperception. In contrast to the bundling and tying studied in the antitrust literature-strategies used by a seller with market power in market A trying to leverage its market power into market B-bundling in response to consumer misperception may occur in intensely competitive markets. The analysis demonstrates that such competitive bundling can be either welfare enhancing or welfare reducing. The Essay considers several "unbundling policies" that can protect consumers and increase welfare in markets where bundling is undesirable.
Do the benefits of competition extend to a world with imperfectly rational consumers? I argue tha... more Do the benefits of competition extend to a world with imperfectly rational consumers? I argue that sellers, operating in a competitive market, will design their products, contracts and pricing schemes in response to consumer misconception, resulting in both efficiency losses and harm to consumers. Under certain conditions, competition provides incentives for sellers to educate consumers and reduce misconception, but these mistake-correction forces are limited. The existence of biased demand, generated by imperfectly rational consumers, creates a market failure – a behavioral market failure. Mandated disclosure, deliberately designed for imperfectly rational consumers, or for sophisticated intermediaries that advise imperfectly rational consumers, can help.
Consumers routinely enter into contracts with providers of goods and services. These contracts ar... more Consumers routinely enter into contracts with providers of goods and services. These contracts are designed by sophisticated sellers to exploit the psychological biases of consumers. They provide short-term benefits, while imposing long-term costs – because consumers are myopic and optimistic. They are excessively complex – because complexity allows sellers to hide the true cost of the product or service from the imperfectly rational consumer. Using both general theory and detailed case studies, this book explains the costs – to consumers and society at large – imposed by seductive contracts, and outlines a promising legal policy solution: Disclosure mandates. Simple, aggregate disclosures can help consumers make better choice. Comprehensive disclosures can facilitate the work of intermediaries, enabling them to better advise consumers. Effective disclosure would expose the seductive nature of consumer contracts and, as a result, reduce sellers’ incentives to write inefficient contr...
In the past decade behavioral economics has established itself as a contender to the throne of ne... more In the past decade behavioral economics has established itself as a contender to the throne of neoclassical economics in the economic analysis of law. The pros and cons of behavioral as compared to neoclassical economics have been vigorously debated at the general, methodology level. But the success or failure of the behavioral challenge will be judged by its ability to
This paper analyzes the costs of permitting corporate managers to sell shares they hold prior to ... more This paper analyzes the costs of permitting corporate managers to sell shares they hold prior to the end of their service at the company. Permitting such selling has an adverse ex ante effect on managers' prior level of effort. This effect exists even when managers do not have private information about the firm's long-term prospects. The existence of such private
Litigants are unrealistically optimistic with regard to the probability of prevailing at trial. T... more Litigants are unrealistically optimistic with regard to the probability of prevailing at trial. This systematic bias is well documented, and has been often invoked to explain breakdowns in pre-trial settlement negotiations. Contrary to existing models that allow for optimism as an exogenous assumption, the present study derives this cognitive bias endogenously. It thus provides a theoretical foundation for optimism in litigation. Quasi-evolutionary forces -market pressure (in the market for legal services) and imitation processes -are shown to favor cautiously optimistic litigants. Moreover, the endogenous optimism model enables an examination of the factors that determine the magnitude of the optimism bias. In particular, it is shown that the legal environment influences the equilibrium level of optimism. Focusing on rules for the allocation of litigation costs, the American rule induces a higher level of optimism, as compared to the British rule. This finding qualifies the conventional wisdom regarding the advantage of the American rule in fostering settlements. Finally, the present analysis is offered as an illustration of a broader theme, that the law can play an important role in determining the types and magnitudes of prevailing cognitive biases. The identification, characterization and analysis of this perceptionshaping role of legal institutions are a novelty of the present study. Behavioral law and economics is revealed as a two-way, rather than a one-way street. Not only do cognitive biases affect the operation of legal rules, but also the legal rules themselves influence the types and magnitudes of observed biases. JEL Classification: B52, C15, C61, C78, D62, D89, K41.
Consumers make mistakes. Imperfect information and imperfect rationality lead to misperception of... more Consumers make mistakes. Imperfect information and imperfect rationality lead to misperception of benefi ts and costs associated with a product. As a result, consumers might fail to maximise their preferences in product choice or product use. A proposed taxonomy of consumer mistakes draws attention to a less-studied category of mistakes: use-pattern mistakes -mistakes about how the consumer will use the product. Use-pattern mistakes are prevalent. Sellers respond strategically to use-pattern mistakes by redesigning their products, contracts and pricing schemes. These strategic design responses often exacerbate the welfare costs associated with consumer mistakes. From a policy perspective, focusing on disclosure regulation, the importance of usepattern mistakes requires more, and better, use-pattern disclosure. In particular, sellers should be required to provide individualised use-pattern information.
Courts and commentators are increasingly concerned about police misconduct — searches and seizure... more Courts and commentators are increasingly concerned about police misconduct — searches and seizures that fail to comply with Fourth Amendment protections. Current doctrine attempts to deter such misconduct with the threat of excluding unlawfully seized evidence. The remedy of exclusion is weak, however, in large part because judges only see cases in which the defendant obviously is guilty. Despite years of proposals, the alternative of money damages is largely unavailable. The problem is exacerbated because Fourth Amendment law is notoriously uncertain. The combination of these three factors results in ineffective deterrence of Fourth Amendment violations. We propose to replace the failed deterrence model with a stringent ex ante warrant requirement. We make a novel case for warrants based on findings from the social sciences. The Court, rather than continuously weakening the warrant requirement, should reverse course and set warrants as the centerpiece of the Fourth Amendment.
A higher expected sanction lowers the crime rate. This intuitive cornerstone of deterrence theory... more A higher expected sanction lowers the crime rate. This intuitive cornerstone of deterrence theory has garnered extensive theoretical and empirical research. The present study focuses on the opposite effects--the effects of the crime rate on the expected sanction. It turns out that these effects are versatile and rich in both the direction and the magnitude of their influence on the
In designing public policy it is not enough to consider the possible reaction of individuals to t... more In designing public policy it is not enough to consider the possible reaction of individuals to the chosen policy. Public policy may also affect the formation of preferences and norms in a society. The endogenous evolution of preferences, in addition to introducing a conceptual difficulty in evaluating policies, may also eventually affect actual behavior. In order to demonstrate the implications of endogenous preferences on the design of optimal public policy, we present a model in which a subsidy policy is set to encourage contributions towards a public good. However this policy triggers an endogenous preference change that results in a lower level of contribution towards the public good despite the explicit monetary incentives to raise that level.
We take a fresh look at the concerns about credit card pricing and empirically investigate whethe... more We take a fresh look at the concerns about credit card pricing and empirically investigate whether the Credit CARD Act of 2009 has been successful in addressing those concerns. The rational choice theory of credit card pricing, which posits that issuers use back-end fees to adjust the price of credit to reflect new information about borrowers' credit risk, predicts that issuers will respond to the Act by using alternative ways to price risk. In contrast, the behavioral economics theory, which posits that issuers use back-end fees because they are not salient to consumers, predicts that issuers will respond by increasing unregulated non-salient prices. If the market is competitive, we argue that the CARD Act should also result in increases in some salient, up-front prices. But we show that if issuers have market power, reductions in non-salient fees may not result in concomitant increases in salient charges. We test these predictions using two datasets on credit card contract terms before and after the CARD Act rules went into effect. We find that the rules have substantially reduced the back-end fees directly regulated by the Act, including late fees and over-the-limit fees. However, unregulated contract terms, such as annual fees and purchase interest rates, have changed little. Post-CARD Act, consumers continue to face high long-term prices and low short-term prices, and imperfectly rational consumers still find it difficult to understand the cost of credit card borrowing. We thus consider potential improvements to the regulatory framework. We argue that improved disclosures that present to consumers the aggregate cost of credit under the contract, based on information about the borrower's likely use of credit, would improve consumer outcomes. Furthermore, we suggest that regulators, rather than focusing on prices that are -too high,‖ should consider limiting the ability of issuers to charge introductory teaser interest rates that are in a sense -too low.‖
Arrow's disclosure paradox implies that information that is not afforded legal protection cannot ... more Arrow's disclosure paradox implies that information that is not afforded legal protection cannot be bought or sold on the market. This paper emphasizes the important relationship between the paradox of disclosure and the boundaries of the firm question. Only legally protected inventions, i.e., patented inventions, may be traded; pre-patent stages of the innovation process may not. Consequently, by force of law, rather than by the guidance of economic principle, pre-patent innovation must be carried out within the boundaries of a single firm.
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Papers by Oren Bar-gill