1. CONTRACTS – Exceptions To Coase’s Theorem October 24, 2006

2. Exceptions to the Theorem of Coase Asymmetric Information Coase Theorem Exceptions To Coase Theorem Transaction Costs - October 17, 2006 Asymmetric Information - October 24, 2006 Empty Core - October 31, 2006

3. Exceptions to the Theorem of Coase Asymmetric Information COLOUR CODE FOR GRAPHS Marginal Cost Curve for Agent (firm, individual) under a strict liability rule Marginal Cost Curve for Agent (firm, individual) under a no liability rule Marginal Cost Curve for Agent (firm, individual) under a negotiated contract that follows the Theoem of Coase Demand Curve for the Agent’s output Marginal Revenue Curve

4. Exceptions to the Theorem of Coase Asymmetric Information COLOUR CODE FOR GRAPHS Expected Marginal Cost Curve for Agent (firm, individual)

5. Exceptions to the Theorem of Coase Asymmetric Information COLOUR CODE FOR GRAPHS (con’t) Average Cost Curve for Agent (firm, individual) with no transaction costs Average Cost Curve for Agent (firm, individual) with transaction costs Profit of Agent (firm, individual) Portion of profit traded in exchange for property rights Portion of profit lost due to a trade in property rights Portion of profit lost due to transaction costs

6. CONTRACTS – Terms And Conditions Exceptions to the Theorem of Coase Property Rules and Liability Rules

7. Exceptions to the Theorem of Coase Asymmetric Information Rules that compensate for market failures (a)moral hazard (b)adverse selection (Cooter – p. 267)

8. Exceptions to the Theorem of Coase Asymmetric Information – Approximate Taxonomy High TransactionLow Transaction Costs Costs PERFECT INFORMATION IMPERFECT INFORMATION DAMAGESINJUNCTION DAMAGESINJUNCTION

9. Exceptions to the Theorem of Coase Asymmetric Information The injunction is the “optimal liability" rule if the “property rule” is strict liability Illegal Labour Strikes Infringement of Intellectual Property Rights

10. Exceptions to the Theorem of Coase Asymmetric Information - Injunction When the relevant economic information is not symmetrically known, then the injunction might serve to more "clearly" assign a property right, instead of damages – Why? Injunctions are clearer and simpler because the determination of damages in the courts can be both imprecise and uncertain when information is asymmetric. »How long will the illegal strike last? »How many copies of Cold Play were downloaded?

11. Exceptions to the Theorem of Coase Asymmetric Information – Injunction The measurement of damages inflicted upon the recipient of pollution may not be reliably verifiable Here the state (or court) might choose to impose an injunction against the polluter so that the polluter will take its own initiative to internalize the pollution.

12. Exceptions to the Theorem of Coase Asymmetric Information - Injunction It may be less costly for the polluters to internalize the pollution than to incur the transaction costs to ascertain the true level of harm in damages. studies experts hiring lawyers going to court

13. Exceptions to the Theorem of Coase Asymmetric Information - Injunction However, such injunctions still work best when transaction costs are relatively low enough to reach private agreements. McKie v. KVP

14. CONTRACTS – Terms And Conditions Exceptions to the Theorem of Coase Asymmetric Information - Signalling

15. Exceptions to the Theorem of Coase Asymmetric Information When information is asymmetric, parties to contracts still communicate information. Two models: Agent To Principal – Signalling Principal To Agent - Screening

16. Exceptions to the Theorem of Coase Asymmetric Information - Signalling Formation Of Contracts Principal Makes An Offer To An Agent Agent Accepts The Offer Performance Of The Contract Agent Sends A Signal to the Principal

17. Exceptions to the Theorem of Coase Asymmetric Information - Signalling Signalling games include agents choosing credentials to signal their ability, without any formal contract offer from principals. EXAMPLE: Voluntary submission of transcripts

18. Exceptions to the Theorem of Coase Asymmetric Information - Signalling A signaling game is an adverse selection game where the informed party (agent) is the first mover. Another Example: A seller offers a warranty on a product sold – What is the signal? Longer the warranty – the lower the cost the seller expects to pay if the product needs to be replaced

19. CONTRACTS – Terms And Conditions Exceptions to the Theorem of Coase Asymmetric Information - Screening

20. Exceptions to the Theorem of Coase Asymmetric Information - Screening Formation Of Contracts Principal makes more than one kind of offer to the Agent. Each Agent type self-selects their optimal choice of offer Performance Of The Contract

21. Exceptions to the Theorem of Coase Asymmetric Information - Screening Screening games include agents choosing those contracts that provide them maximum recovery at least cost. EXAMPLE: Insurance contracts

22. Exceptions to the Theorem of Coase Asymmetric Information - Screening If a principal does not know which agent type is present, he or she “writes” more than one type of contract to “sort” the agent types EXAMPLE: Suppose an agent does not want to “disclose” their entire wealth. This “low disclosure” agent can choose cheaper insurance with more limited coverage.

23. Exceptions to the Theorem of Coase Asymmetric Information - Screening A major part of contract theory is default rules. Contracts are usually incomplete and therefore a court or legislature must fill gaps. This involves “sub-agencies”

24. Exceptions to the Theorem of Coase Asymmetric Information - Screening If a court anticipates that more than one “contract” type could appear in court on a breach of contract issue, it can “write” different rules to match each contract type. EXAMPLE: Suppose an agent does not want to “disclose” their entire wealth to a security agent. This “low disclosure” agent has, in effect chosen a “lower” recovery rule for damages.

25. Exceptions to the Theorem of Coase Asymmetric Information - Screening A principal in a private bilateral contract relationship writes a contract that may serve to “sort” or “separate” agents into more efficient contracts A court in a private bilateral agency relationship writes a rule that may serve to “sort” or “separate” contracts into more efficient outcomes

26. Exceptions to the Theorem of Coase Asymmetric Information - Screening. PRINCIPAL AGENT PRINCIPAL AGENT Court (as a “Principal”) imposes a rule with choices on a Principal – Agent contract

27. CONTRACTS – Terms And Conditions Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145

28. Agent Accepts The Offer Court Imposes A Rule with Choices on a Principal and an Agent Principal Makes An Offer To An Agent Performance Of The Contract Agent Accepts The Offer Sub- Agency

29. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 In Hadley v. Baxendale, a court established a rule which attempted to avoid adverse selection results in breach of contract cases

30. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 Hadley owned a gristmill Hadley entered into a contract with Baxendale, a carrier, to carry a broken crankshaft to engineers to Greenwich for repair

31. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 Repair of the crankshaft was delayed several days As a result, Hadley’s mill was shut down while awaiting return of the repaired shaft

32. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 Hadley claimed profits lost during the shutdown period Trial court rules in Hadley’s favour This was reversed in the Court of Appeal This court established or reaffirmed the primary rule of contract law: “... that the amount which would have been received if the contract had been kept, is the measure of damages if the contract is broken."

33. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 The Court of Appeal held Hadley’s lost profits were not recoverable Hadley had not made full disclosure to Baxendale about his reliance on the damaged crankshaft in order to emphasize the urgency of the problem

34. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 Only what is “disclosed” to Baxendale can be included in the recovery of damages: Now, if the special circumstances under which the contract was actually made were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages resulting from the breach of such a contract, which they would reasonably contemplate, would be the amount of injury, which would ordinarily follow from a breach of contract under these circumstances so known and communicated.

35. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 However, Baxendale was still liable for “some damages” due to his inattention to the delivery of the crankshaft: But, on the other had, if these special circumstances were wholly unknown to the party breaking the contract, he, at the most, could only be supposed to have had in his contemplation the amount of injury which would arise generally, and in the great multitude of cases not affected by any special circumstances, from such breach of contract.

36. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 So the Court of Appeal established two rules for recovery (or two (2) branches of the rule) Recovery of damages is lower when Hadley chooses not to disclose the nature of his reliance in the crankshaft Recovery of damages is higher had Hadley chosen to disclose the nature of his reliance in the crankshaft

37. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 Agent Accepts The Offer Court Imposes A Rule with Choices on a Principal and an Agent Sub-Agency

38. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 E H E L A Court imposes a “complete” rule with the agents and principals In this case two “different” agents – “two” different contracts “two” different rules H – high disclosure principal and agent L- low disclosure principal and agent

39. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 The objective of the rule is that the two (2) types of principals reveal themselves through the choice of disclosure the principals reveal and the agents receive

40. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 The Hadley default rule serves to distinguish two contractual types who differ in a single respect. The low value type places a lower value disclosure and will, therefore, receive low damages in the event of default. The high value type places a higher value on contract performance and will, therefore, receive high damages in the event of default.

41. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 EHEH

42. The high disclosure rule (analogous to the high risk budget constraint) acts as an “imposed” incentive compatibility constraint on the low disclosure agents who either may not sue or who may not enter contracts In other words, high-disclosure agents impose a negative “non-disclosure” externality on low-disclosure agents under the Expectation Damages Rule

43. Expectation Damages Hadley v. Baxendale (1854), 9 Ex. 341, 156 E.R. 145 W2W2 W1W1 EHEH

44. A separating equilibrium “sorts” the contracts so that: (i)the low-disclosure agents gravitate towards a rule with lower recovery of damages (ii)the high-disclosure agents gravitate towards an expectation damages rule that would take economic loss (loss of profits) into account

45. Exceptions to the Theorem of Coase Asymmetric Information – Screening Sometimes the court has to “separate” the contracts that private parties negotiated as “pooling contracts”

46. Exceptions to the Theorem of Coase Asymmetric Information – Screening Macaulay v. Schroeder Publishing Co. Ltd. (1974). A standard form contract “Pooled” bad writers with good writers by subsidizing the “bad” writers with profits made by the “good” writers House of Lords – Highest English court – strikes down contract with an “efficiency” argument against “pooling” contracts

47. Exceptions to the Theorem of Coase Asymmetric Information – Screening What if the parties agree to a termination damages clause in the contract?

48. Exceptions to the Theorem of Coase Asymmetric Information – Screening The “liquidated damage rule” prevents enforcement of contractual damage measures that require the Agent, if it breaches the contract, to transfer to the Principal a sum that exceeds the net gain the Principal expected to make from performance

49. Exceptions to the Theorem of Coase Asymmetric Information – Screening This rule permits the Agent to transfer less than the Principal’s expectation that would be allowed under the Expectation Damages Rule. This is an example of a “limited liability” condition inserted into the contract

51. CONTRACTS – Terms And Conditions Exceptions to the Theorem of Coase Expectation Damages – Single Moral Hazard

52. Exceptions to the Theorem of Coase Asymmetric Information – Remedies. Agent 2 has theexclusive use to itsproperty rights Agent 1 creates a harmful nuisance that hurts Agent 2 economically.

53. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Agents operate two firms: a 1 = output of Agent 1 a 2 = output of Agent 2

54. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Perfect Information – Constant Marginal Costs Strict Liabilty Rule a1a1

55. Exceptions to the Theorem of Coase Asymmetric Information - Remedies The profit function of Agent 1 is:  1 = pa 1 – C(a 1 ) The pollution function of Agent 1 is: D(a 1 ) = (a 1 )^ 2

56. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Perfect Information – Increasing Marginal Costs Strict Liabilty Rule No Liability Rule a1a1

57. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Agent 1 takes into account the ability of Agent 2 to sue it when it maximizes its profits: Output = (a 1 )* = 5/8 Pollution = (a 1 )^ 2 * = 25/64

58. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Perfectly Competitive-Agent 1 Monopoly Market – Agent 1 S D P a1a1 MC 1 P PC PMPM LATC Strict Liability Rule Exceptions to the Theorem of Coase Asymmetric Information - Remedies

59. Perfectly Competitive-Agent 2 Monopoly Market – Agent 2 S D P a1a1 MC 2 P PC PMPM LATC Strict Liability Rule MC 2

60. Exceptions to the Theorem of Coase Asymmetric Information - Remedies PRINCIPAL Agent 1 Offers a Bribe or a Transfer Payment To Agent 2 AGENT Agent 2 promises to endure the pollution in exchange for the payment which makes it better off promise payment

61. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Damages suffered by Agent 2 without the payment to Agent 1 would be: D(a P1 ) = 25/64 However, if the ideal of “0-pollution” operates for Agent 2 : D(a O1 ) = 0 Minimum Payment To Agent 2 25/64

62. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Perfectly Competitive-Agent 2 Monopoly Market – Agent 2 S S = MC 2 D P a1a1 MC 2 SATC P PC PMPM LATC Strict Liability Rule

63. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Profit earned by Agent 1 without the payment to Agent 1 would be:  1 (a SO1 ) = 25/16 Profit earned by Agent 1 under the free market would be:  1 (a P1 ) = 25/12 Maximum Payment from Agent 1 25/48

64. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Perfectly Competitive-Agent 1 Monopoly Market – Agent 1 S S = MC 1 D P a1a1 MC 1 SATC P PC PMPM LATC Strict Liability Rule

65. Exceptions to the Theorem of Coase Asymmetric Information - Remedies The “optimal” bribe or transfer payment lies within a “core”: 25/64 < PAYMENT TO AGENT 2 FROM AGENT 1 < 25/48

66. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Social surplus increases under the contract. No party can be worse off. Agent 1 S D P a1a1 PMPM PMC SMC CMC

67. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Social surplus is improved to the most efficient or optimal amount irregardless of which agent has the property rights. Agent 2 S D P a1a1 PMPM PMC SMC CMC

68. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Agent 2 S D P a2a2 PMPM Agent 1 S a1a1 CMC Maximum Joint Social Surplus

69. Exceptions to the Theorem of Coase Asymmetric Information - Remedies While there may be no “incentive” to break this contract, other “interventions” may happen: The contract could be frustrated A new owner might ignore the contract and increase pollution The downstream victim might decide to sue irregardless of the victims compensation A storm or hurricane

70. Exceptions to the Theorem of Coase Asymmetric Information - Remedies What happens: There is a reduction in optimal social surplus A 1 may sue A 2 for its loss of the reduced surplus A 2 may sue A 1 for its loss of the reduced surplus Could this happen?: There must be full disclosure by each party Usually, there is not In this case, since the strict liability rule applies, the “burden” is on A 1 to make sure the contract succeeds

71. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Agent 2 S D P a2a2 PMPM Agent 1 S a1a1 CMC Maximum Joint Social Surplus

72. Exceptions to the Theorem of Coase Asymmetric Information - Remedies The Contract Model – Implied Insurance A 1 is the superior risk bearer if it is in the best position to prevent or meet the risk »Get the relevant information at least cost »Insure against the risk at least cost The level of effort, a 1, includes a “precautionary input” to reduce the risk of breach of contract

73. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Perfect Information – Increasing Marginal Costs $C 1 Strict Liabilty Rule Contract Liability Rule a1a1

74. Exceptions to the Theorem of Coase Asymmetric Information - Remedies The Contract Model – Expected Costs A 1 is the superior risk bearer As the level of effort, a 1, increases, the likelihood of a “breach of contract”, p( a 1 ), decreases As p( a 1 ) decreases, the level of “expected damages”, Dp( a 1 ), decreases, where D = the loss A 1 bears because the contract failed D has two components »The difference in profit A 2 would have received if the contract was performed and what A 2 actually gets »The difference in profit A 1 would have received if the contract was performed and what A 1 actually gets

75. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Imperfect Information Decreasing Marginal Costs Due to Precaution Increasing Marginal Costs Due To Production Strict Liabilty Rule – MC 1 Contracted Liability Rule – MC 1 Expected Liability – MC 1 a1a1 $C 1

76. Exceptions to the Theorem of Coase Asymmetric Information - Remedies The Contract Model – Expected Costs What exactly is p(a)? Certain underlying assumptions might be made about p(a) p(a) is distributed in accordance with an underlying probability distribution where the area under the probability curve is equal to 1 For example »Uniform distribution »Normal distribution

77. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Uniform Distribution a1a1 Area Under the Probability Curve = 1.0

78. Exceptions to the Theorem of Coase Asymmetric Information - Remedies Normal Distribution a1a1a1a1 Area Under the Probability Curve = 1.0

79. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy a 1 = level of precaution invested by the agent-promisor (Agent 1) against breach of contract against (Agent 2) a 2 = level of reliance invested by the agent-promisee (Agent 2) in Agent 1 (polluter)

80. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy p(a 1 ) = Probability of No Breach Probability of Performance A Completed Contract p’(a 1 ) > 0 More effort results in more precaution against breach p’’(a 1 ) < 0 Diminishing “returns” to precaution as more effort invested

81. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Agent 1 can take costly precaution that increases the probability that he or she performs the contract as promised (Cooter, 4 th, p. 298)

82. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy $C 1 a1a1 R 2 [P(a 1 )] R 2[1- P(a 1 )] Agent 1’s Marginal Cost Curve (under the Coasean Contract)

83. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy R 2[P(a 1 )] = Total revenue of Agent 2 under the contract if the contract is fully performed R 2[1 - P(a 1 )] = Total revenue of Agent 2 under the contract if the contract is breached

84. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy  Profit of Agent 2 if contract is performed   P (a 2 ) = R 2[P(a 1 )] - a 2  Profit of Agent 2 if contract is not performed   NP (a 2 ) = R 2[1-P(a 1 )] - a 2

85. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Solving the “legal problem” involves maximizing the joint social surplus of the parties Both Cooter and Posner refer to the concept of “optimal social surplus” by the term “efficiency” []Cooter, R., Law and Economics - Mathematical Appendix, (4 th ed.) pp. 298-299

86. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Y = C(a 1,a 2 ) = p(a 1 )R P (a 2 ) + [1 - p(a 1 )]R NP (a 2 )Contract a 1, a 2 - effort inputs - precaution - hours of work - joint investment

87. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy The parties will choose that level of effort which maximizes their respective incentive compatibility constraints: Max [p(a 1 )R P (a 2 ) + [1 - p(a 1 )]R NP (a 2 )] - a 1 - a 2 []Cooter, R., Law and Economics - Mathematical Appendix, (4 th ed.) pp. 298-299

88. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy 1= marginal expenditure p'(a 1 )[R P (a 2 ) - R NP (a 2 )] = marginal expected revenues of Agent 2 []Cooter, R., Law and Economics - Mathematical Appendix, pp. 298-299

89. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy 1= marginal reliance expenditure p(a 1 )R P '(a 2 ) + [1 - p(a 1 )]R NP '(a 2 ) = net marginal expected increase in revenues Cooter, R., Law and Economics - Mathematical Appendix, p. 299

90. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Incentive Compatibility Constraint of AGENT 2 C 2 (e 1,e 2 ) - 1 = 0 [p(a 1 )R P '(a 2 ) + [1 - p(a 1 )]R NP '(a 2 )] = 1 net marginal expected increase in revenues = marginal reliance expenditure

91. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Solving the system of incentive compatibility constraints [p(a 1 )R P '(a 2 ) + [1 - p(a 1 )]R NP '(a 2 )] = 1 p'(a 1 )[R P (a 2 ) - R NP (a 2 )] = 1 yields a 1 = a* 1 and a 2 = a* 2

92. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Axes $C 1 a1a1 P P  NP Marginal Cost Curve of Agent 1 a 10 a 1 * a 11

93. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy e 1 = e* 1 and e 2 = e* 2 generate “socially optimal” reliance and precaution However, since 0 < p(e* 2 ) < 1 then the “actual solution” to the principal’s problem will lie within the “core” y 0 < e* 1 < y 1

94. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy “Liability rule” or “liability marginal cost curve” for Agent 1 is added in orange to the joint social surplus of the parties Max [p(e 2 )R P (e 1 ) + [1 - p(e 2 )]R NP (e 1 )] - e 1 - e 2 - [1-p(e 2 )]D e

95. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy Property rule is added in orange as a “second” incentive compatibility constraint to the Agent 1 p'(a 1 )[R P (a 2 ) - R NP (a 2 )] = 1 Marginal expected revenue = marginal expenditure 1 = p’(a 1 )D e Marginal cost of precaution = marginal reduction in expected liability Cooter, (4 th ) pp. 300 - 301

96. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy $C 1 a1a1 P P  NP Marginal Cost Curve of Agent 1 Expected Marginal Cost Curve of Agent 1 under Expectation Damages a 10 a 1 * a 11

97. Exceptions to the Theorem of Coase Asymmetric Information – Optimal Remedy D e = R P (e 1 ) - R NP (e 1 )] Expectation Damages – D e - puts the principal-promisee in the same position as if the contract had been performed (Cooter, 4 th, p. 299)

98. Exceptions to the Theorem of Coase Modification, Renegotiation and Re-Contracting

99. Modification, Renegotiation and Re-Contracting How does one distinguish opportunistic behaviour (breach of contract) from socially optimal modification of contract (recontracting)?

100. Modification, Renegotiation and Re-Contracting The Contract Model – Implied Insurance Courts presume against renegotiation or re-contracting in contracts in the absence of very clear clauses allowing changes in the contract. »Unlimited modification undermines the “efficiency” of the implied insurance in the contract

101. Modification, Renegotiation and Re-Contracting Aivazian, Trebilcock and Penney (1984) argue is safe to enforce modifications when It is not clear who the superior risk bearer is – insurance would not be an issue then. The risk is to small to worry about

102. Modification, Renegotiation and Re-Contracting A,T & P recognize that the “Cooter emphasis” on “efficient breach” might encourage too much flexibility and lead to opportunistic behaviour A, T & P an “ex ante” approach with a long-term incentive structure that would both anticipate changes and reduce the transaction costs of modification

103. Modification, Renegotiation and Re-Contracting Unambiguous laws Allowing modification Disallowing modification have no impact on the optimal location of the contract point in these strategic changes (ATP – p. 190)

104. Modification, Renegotiation and Re-Contracting Laws disallowing modification in strategic situations are more efficient in high transaction cost jurisdictions since parties minimize both agency and transaction costs following the “ex ante” approach to contract design – “Get it right the first time” (ATP – p. 190) Plea bargains Separation agreements

105. Modification, Renegotiation and Re-Contracting Laws disallowing modification in economic changes are still more efficient unless The “superior risk bearer” is too difficult to identify The type of risk is remote (wars – ATP – p. 207) in which cases contract modification should happen. (ATP – pp. 196-197)