Discussion Paper Details

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Title: Optimal Contracts with Enforcement Risk

Author(s): Nicola Gennaioli

Publication Date: May 2011

Keyword(s): imperfect judicial enforcement and optimal contracts

Programme Area(s): Development Economics, Financial Economics and Public Economics

Abstract: I build a model where potentially biased judges verify complex states by interpreting an imperfect signal whose noise captures factual ambiguities. In a sales and a financial transaction I show that judicial biases amplify and distort factual ambiguities, creating enforcement risk. To insure against such risk, parties write simple non-contingent contracts that optimally protect the party that is most vulnerable to judicial error. These results shed light on the empirical association between law and finance and rationalize salient features of real world enforcement regimes.

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Bibliographic Reference

Gennaioli, N. 2011. 'Optimal Contracts with Enforcement Risk'. London, Centre for Economic Policy Research.