1 Agenda for 14th Class Information (continued) Rights & Ordinary Understanding Assignment for Next Class Readings –## 79, –#85(stopping on the end of the 2 nd full paragraph on p. 324) –#86 –#88 (stopping after the first block quote on p. 335) –#89 –Optional. All other readings between ## 78 & 90 Questions to think about / Writing assignment –See next page

2 Assignment (cont.) Questions to think about –What do you think is the right thing to do in the Trolley case? Why? –What do you think is the right thing to do in the Transplant case? Why? –P. 312 Question 7 Question to Think About & Writing Assignment –Ex 15. Gould Virus

3 Last Class – Information I Information problems are transactions costs –They impede potentially beneficial transactions Sometimes can be addressed through private action –Consumer Reports –Incentive contracts Sometimes can be addressed through government action –Nutritional labeling –Mandatory insurance cures adverse selection problem Moral hazard. – Incentive problem after contract entered into Person with fire insurance takes less care Employee exerts less effort –Informational problem, because if information were costless, problem could be completely resolved by contract –Solutions Monitoring Contracts which give incentives

4 Last Class – Information II Adverse selection – –Lack of information before contract entered into Health insurance Used car –Bad information can block transaction entirely People don’t buy or sell if don’t have sufficient information about transacting partner –Solutions Information gathering before contracting Warranties Mandatory insurance Principal-agent problem –Not separate information problem But context in which moral hazard or adverse selection may occur –Lawyer-client Moral hazard – overbilling Adverse selection – how choose right lawyer? –Employer employee –Solutions See above – incentive contracts, information gathering, monitoring

Questions on pp. 253ff 5. Consider the way home mortgages are often sold. A bank contracts with a mortgage broker. A mortgage broker is an independent businessperson, not an employee of the bank. The mortgage broker solicits customers and, when a customer wants a loan, helps the customer fill out the relevant paperwork and sends the paperwork to the bank for approval of the loan. a) The contract with the mortgage broker might specify that the mortgage broker gets a fixed salary – perhaps $3000 per month. What problems might occur under such a contract? Would the bank be wise to offer such a contract? b) The contract with the mortgage broker might specify that the mortgage broker gets a percentage of the value of all loans approved. For example, the mortgage broker might get 0.5% of the value of each loan, which would be $2500 on a $500,000 loan. What problems might occur under such a contract? Would the bank be wise to offer such a contract? c) What macro-economic problems might occur if most loans were negotiated through contacts such as those described in (b)? d) Can you think of a better contract between the bank and the mortgage broker? e) The relationship between a bank and a mortgage broker presents all three types of asymmetric information problems discussed in readings ##50- 51, supra – adverse selection, moral hazard, and principal-agent. Identify which aspects of the relationship present which kinds of problems.

Gilson, Role of Lawyers Functions of Lawyer –Litigate –Advise –Draft & negotiate contracts (transactional lawyer) Role of Transactional Lawyer –Transaction Cost Engineer Reduce transactions costs for benefit of both parties Solve informational problems Lawyers often cynically viewed just transactions costs –But Gilson suggests that function of (good) lawyer is to reduce transactions costs –Value Creation Function of (good) lawyer is to “create value” –i.e. increase the pie –Not just bargaining to get greater share of surplus for client –Other roles Regulatory compliance Getting most for client

Gilson, Corporate Acquisition Agreement Lawyer as transactions cost engineer –Lawyer create value (increases pie) by reducing transaction costs, especially informational problems Representations and Warranties –Detailed statements of facts concerning the relevant business Including accuracy of financial statements, absence of particular liabilities, ownership and condition of key assets, pending litigation. –Seller liable if turn out to be false –Purpose. Provide credible information that is key to transaction and its pricing Earn out provisions –Part of price depends on performance of business Part of payment delayed and contingent on how well business does –Helps parties to agree on deal, even if disagree on profitability of business –Also gives former owners an incentive to help

Gilson, Corporate Acquisition Agreement II Covenants and Conditions –Covenants. Agreement on how owner will conduct business in period between signing of contract and transfer of ownership –Conditions, if not satisfied, relieve buyer of obligation to purchase

Question on pp. 272ff 1. Would you characterize the informational problem in a typical corporate acquisition agreement as primarily an adverse selection, moral hazard, or principal-agent problem? 2. Gilson mentions “Covenants and Conditions” as one of the four main components of an acquisition agreement, but he doesnt say much about them. What kind of informational problem do you think they address? Adverse selection? Moral hazard? Principal- agent? 3. Gilson focuses on private, contractual solutions to the informational problems posed by corporate acquisitions. Is there a role for courts, legal rules, and/or legislation?

Rights Instrumentalism –Economic analysis and utilitarianism are “instrumentalist” theories Rules are justified by their consequences –E.g. impact on net benefits, happiness, etc. Utilitarians and economic analysts favor rights only to the extent that rights are helpful to their goals –John Stuart Mill is probably most famous instrumentalist/utilitarian philosopher Non-instrumentalist theories –Are not about consequences –Ordinary understanding –Corrective justice Justice requires injurer to compensate victim, even if doing so has no deterrent effect –Nozick, “side constraints” Some things can’t be done, no matter how beneficial the consequences –Rawls, Rights, equality and fairness take priority over economic maximizing –Sometimes called “deontological theories” –Immanuel Kant is probably the most famous deontological philosopher

11 Questions. P. 288f 2. Professor Kull believes that engagement ring disputes should be decided in accordance with “individual choices, intentions, understandings and expectations.” What are people’s understandings with respect to engagement rings? Consider three possible understandings: (a) that the ring is an unconditional gift, so the fiancée gets to keep the ring no matter what happens; (b) that the ring is a conditional gift and the fiancée needs to give it back, unless the groom-to-be was at fault in calling off the engagement; and (c) that the ring is a conditional gift, and the fiancée needs to give it back if the marriage doesn’t take place, no matter who was at fault in calling off the engagement. Is there widespread social agreement as to which of these three understandings is correct? Or do all three competing understandings have their adherents? If so, should a judge or jury inquire into the parties’ own understanding? The understanding of their peers or cultural group? 3. When the Pennsylvania Supreme Court expresses its decided lack of enthusiasm for inquiring into the details of engagements gone awry, and its concomitant preference for a simple rule which settles such disputes while avoiding detailed inquiry into their facts, is it suggesting that traumatic events in people’s personal lives are too unimportant for courts to spend time considering them? If not, why is it that administrative convenience is more important than doing justice?

12 Questions. P. 288f 9. If the court was merely interested in simplifying the law why didn’t it just announce a rule that engagement rings are unconditional gifts so that the groom-to-be is never entitled to the return of the ring? That would eliminate suits for the return of engagement rings and the “romantic bailment” problem. Does treating the ring as an unconditional gift create any new problems? Suppose a would-be groom gives a woman he wants to marry an engagement ring and the wedding is never consummated. The woman intends to sell the ring and keep the profit. The would-be groom concludes that she never intended to marry him at all but was happy to have a valuable ring to sell. He demands the ring back. Do we have to decide if there are conditions on this unconditional gift? 13. Professor Kull appears to be appalled by the Harvard Law Review Note which suggests that the legal rule regarding the return of engagement rings might have an effect on the conduct of persons contemplating marriage Is he correct to dismiss this possibility as something that is simply not worth entertaining? The following Note on “‘Corrective Justice’ and ‘Private Law’” considers some reasons why Professor Kull might think this.

13 Questions, p Is Lindh a case where consideration of incentive effects and fairness suggest different outcomes? Can you think of incentive and fairness arguments in favor of returning the ring to Lindh? In favor of letting Surman keep the ring? 5. Should it matter that figuring out who was at fault in Lindh and similar cases could be very costly, both to the parties and to the public which pays judges’ salaries and funds other court costs? Kull thinks legal rules should establish liability even when they only provide compensation for harm, but do not "change the world for the better … by reducing the incidence of losses." That is, he believes that a legal system should incur costs (the costs of litigation and adjudication) even when, in economic terms, all litigation will do is transfer money from one party to another, with no beneficial ex ante effects. That is, he believes that legal systems should make decisions which would fail cost-benefit analysis. Why does Kull think it worthwhile for the legal system to decide such disputes? Do you agree?