Vanderbilt Law Review

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In The Problem of Social Cost,' the foundational article of the law and economics movement, Ronald Coase suggested that when transaction costs are zero, the initial allocation of a legal entitlement is irrelevant to its eventual ownership. Assuming no transaction costs, the Coase Theorem predicts that if party A values an entitlement more than does party B, A will keep the entitlement if it is initially allocated to him, and he will buy it if it is originally allocated to B. This powerful insight depends on the behavioral assumption that an individual's valuation of entitlements does not depend on ownership; that is, A values an entitlement neither more nor less if he is initially allocated that entitlement than if it is initially given to B.

The assumption that preferences are exogenous to entitlement allocations is empirically testable, however, and has been demonstrated to be false, at least under some conditions. The empirical evidence, labeled alternatively the "status quo bias," the "endowment effect," or the "offer/asking price gap," instead suggests that the initial allocation of legal entitlements can affect preferences for those entitlements. The consequence is that completely alienable legal entitlements will be "sticky"-that is, tend not to be traded-even when such stickiness cannot be explained by transaction costs. The evidence thus describes an important flaw in the Coase Theorem's mighty armor. The principle goal of one branch of the discipline of "behavioral law and economics" or "law and behavioral science"s is to explore the legal implications of this flaw.

In a previous article, I argued that contracting parties are less likely to bargain around background-or "default"--contract terms established by the law than the Coase Theorem would predict because the parties are likely to view default terms as a constituent part of the status quo, much like an entitlement. The claim, if correct, has both positive and normative implications for the analysis of contract default rules. On the positive side, it leads to predictions that differ from traditional law and economics analysis regarding what circumstances are necessary for contracting parties to bargain around default rules." On the normative side, it suggests somewhat different strategies (again, compared to traditional law and economics analysis) for lawmakers interested in selecting contract default rules that will enable private bargainers to maximize allocative efficiency.

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