In most of the contract theory literature, contracting costs are assumed either to be high enough... more In most of the contract theory literature, contracting costs are assumed either to be high enough to preclude certain forms of contracting, or low enough to permit any contract to be written. Similarly, researchers usually treat renegotiation as either costless or prohibitively costly. This paper addresses the middle ground between these extremes, in which the costs of contracting and renegotiation can take intermediate values and the contracting parties can themselves influence these costs. The context for our analysis is the canonical problem of inducing efficient relationspecific investment and efficient ex post trade. Among our principle results are: (i) The efficiency and complexity of the initial contract are decreasing in the cost to create a contract. Hence, the best mechanism design contracts can be too costly to write. (ii) When parties use the simpler contract forms, they require renegotiation to capture ex post surplus and to create efficient investment incentives. In some cases, parties want low renegotiation costs. More interesting is that, in other cases, parties have a strict preference for moderate renegotiation costs. (iii) The effect of Contract Law on contract form is significant but has been overlooked. In particular, the law's interpretive rules raise the cost of enforcing complex contracts, and thus induce parties to use simple contracts. Worse, the law also lowers renegotiation costs, which further undermines complex contracts and is also inappropriate for some of the simpler contracts.
ABSTRACT We consider legal rules that determine the price at which minority shareholders can be e... more ABSTRACT We consider legal rules that determine the price at which minority shareholders can be excluded from the corporate enterprise after a change in control. These rules affect investment after such a change, as well as probability of the change itself. Our principal results are that minority shareholders should be given the value that their interest would have had were no later investment made and that this rule is best implemented in large companies by awarding the minority the preinvestment market value of their shares. The former aspect of our proposal is consistent with much current law but is rejected by many modern law reformers; the latter aspect of our proposal is novel. Copyright 1996 by the University of Chicago.
Our paper offers the first justification for the U.S. bankruptcy code, in which firms are not all... more Our paper offers the first justification for the U.S. bankruptcy code, in which firms are not allowed to commit themselves ex-ante in their lending agreements either to (Chapter 7) liquidation or to (Chapter 11) reorganization in case of distress ex-post. If fire-sale liquidation imposes negative externalities on their peers, then firms can be collectively better off if they are all forced into a no-opt-out choice (a mandatory "menu"). This is the case even though they would individually want to commit themselves to liquidation, and it is collectively better for them than voluntary contract choice or mandatory liquidation. Our paper's innovation is thus to show not when a later choice should be prohibited, but when a later choice should be mandatory.
ABSTRACT A problem in economic contract theory is to know when parties can create efficient inves... more ABSTRACT A problem in economic contract theory is to know when parties can create efficient investment incentives with contracts. A problem in legal contract theory is to develop rules to guide courts in interpreting contracts. These problems are related because the law's interpretive rules affect how parties describe what they want to trade in their contracts, and when parties will offer evidence at trial of their ex ante intentions. The more illuminating contacts and evidence production are, the better contracting works. Hence, some interpretive rules are more efficient than others. We study these rules and show, among other things, that (a) an optimal interpretive rule trades off accuracy in recovering the parties' ex ante intentions against the costs of contract writing and evidence production; (b) an optimal rule sometimes prevents parties from introducing relevant evidence and deters some parties from writing contracts (in these cases, communicating the parties' intentions to an adjudicator would not be worth its costs); (c) different enforcement institutions — courts and arbitrators — exist in equilibrium; (d) contract writing and evidence production are substitutes, while enforcer expertise (appropriately defined) and contract writing are complements; (e) under an optimal enforcement scheme, parties need not give interpretive instructions to enforcers because the enforcers and the parties share the same goal (to create efficient incentives to invest); and (f) current courts are more interested in accuracy than in incentives, so parties may want to send interpretive instructions to them.
The fees of professionals (financial advisors, lawyers, accountants) are a substantial fraction o... more The fees of professionals (financial advisors, lawyers, accountants) are a substantial fraction of bankruptcy costs. Scholars have considered how best to reduce these costs but have not considered how they should be allocated among creditors. Creditors can spend redistributionally (to violate or uphold absolute priority) or productively (to increase the value of the bankrupt firm). An efficient bankruptcy cost allocation scheme should discourage redistributional and encourage productive creditor spending. We consider the desirability of various allocation schemes in a model in which senior and junior creditors can engage in both types of spending. We show that (1) the current U.S. cost allocation system is unsatisfactory because the scheme partially reimburses junior expenses for professionals but does not reimburse senior expenses and (2) a cost allocation scheme that approaches the first-best solution and is implementable would delegate the issue of professionals' cost reimbursement to the debtor in possession.
You will come first of all to the Sirens, who are enchanters of all mankind and whoever comes the... more You will come first of all to the Sirens, who are enchanters of all mankind and whoever comes their way; and that man who unsuspecting approaches them, and listens to the Sirens singing, has no prospect of coming home and delighting his wife and little children as they stand about him in greeting, but the Sirens by the melody of their singing enchant him. They sit in their meadow, but the beach before it is piled with boneheaps of men now rotted away, and the skins shrivel upon them. You must drive straight on past, but melt down sweet wax of honey and with it stop your companions' ears, so none can listen; the rest, that is, but if you yourself are wanting to hear them, then have them tie you hand and foot on the fast ship, standing upright against the mast with the ropes' ends lashed around it, so that you can have joy in hearing the song of the Sirens; but if you supplicate your men and implore them to set you free, then they must tie you fast with even more lashings.l T HIS Article asks (i) whether tort liability should be imposed on the makers of substances that are legal to sell but that may addict users, if the makers have not warned users of the risk of addiction, and (ii) whether the state should create a standard warning against addiction that the makers of possibly addicting substances must give. There is little authority on the first question.2 Recently, plaintiffs
We thank Elizabeth Chorvat and James Yeagle for research assistance. 1 A sunk cost or relation-sp... more We thank Elizabeth Chorvat and James Yeagle for research assistance. 1 A sunk cost or relation-specific investment is partly or totally nonredeployable. For example, steel rods ordered for a project are redeployable because a party can sell them on the market; rods that are fabricated into particular shapes would not be redeployable if the shapes were specific to the contract party's needs.
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Papers by Alan Schwartz