The Quality of Law: Judicial Incentives, Legal Human Capital and the Evolution of Law

1. The Quality of Law: Judicial Incentives, Legal Human Capital and the Evolution of Law Gillian Hadfield USC and Columbia University The Dynamics of Institutions Paris, October 2008

2. Researchers have accumulated evidence that the bottom-up approach to law has proven to be superior for economic development to more top-down approaches. A series of studies compare development outcomes in countries with a common-law tradition to those with a civil-law tradition. William Easterly, The White Man’s Burden (2006) In [the common-law] tradition judges are independent professionals who make rulings on cases based on precedents from similar cases. The principles of the law evolve in response to practical realities and can be adapted to new situations as they arise. In [the civil-law] tradition, laws are written from the top down by the legislature to cover every possible situation. Judges are glorified clerks just applying the written law…the law is less well adapted to reality on the ground and has trouble adapting to new situations as technology and society change

3. Does legal institutional design affect the (economic) quality of law? • Empirical literature • Legal origin affects quality of law in finance, labor, business entry, corporate governance; formality; economic growth [LLSV, Djankov, Mahoney, Simon, Botero] • Transplant effect [Berkowitz et al, Botero et al, Beck et al] • Why/how • Judicial independence/corruption [LLSV, Glaeser & Shleifer, Mahoney] • Judicial discretion/information [Hayek, Merryman, Beck et al, Anderlini et al] • Evolution of common law [Posner, Priest, Rubin, Cooter et al] • Rules versus standards [Kaplow, Rose, Diver, Shavell, etc.]

4. Problems in existing literature • Code as determinative; institutionally thin • Behavior as institution • Judicial information as primitive • Judicial incentives as personal • Distinguish behavior & institutions • Model judicial incentives, learning and adaptation of law • Identify institutional parameters

5. Framing the Model (heterogeneous defendants) • Existing legal rule: • All defendants liable for damages D • Sub-optimal • Optimal rule: • “Good” types not liable • Prob “good” = p • Under what conditions and to what extent will legal regime switch to optimal rule?

6. Sequence • Defendant “proffers” defense • Judge adopts or not • Defendant decides to invest in evidence/argument or not • Judicial decision on liability reached • Liable if no evidence/argument • If evidence/argument presented, result determined by judicial accuracy/error

7. Defendant’s Legal Strategy Choice Investment in costly evidence/argument to support claimed defense Good type: Invest if Bad type: Invest if Assume good less likely held liable than bad:

8. When are defendants willing to invest in rule change? • If none seek • If only good seek • If both seek

9. When are judges willing to risk rule change? • If judge will risk type 1 error iff where

10. When are judges willing to risk rule change? If judge will risk type 1 & type 2 error iff

11. Proposition 5: Necessary & Sufficient Conditions for Rule Change Rule change will occur in period 1 iff 1) neither too high nor too low 2) sufficiently high relative to 3) sufficiently low

12. Observations about Rule Change • If all three conditions do not hold, no rule change period 2 • If conditions met, adopted in period 1 by proportion of judges equal to • may persist despite high judicial rewards, low legal costs • Low legal costs may discourage rule change due to risk of type 2 error

13. Dynamics: Judicial Error and Legal Human Capital Embedded information with defendants Mechanisms of information sharing among judge (precedent, judicial hierarchy/training)

14. Welfare analysis • Rule change in period 1 reduces legal error period 2 if is informative • Optimal extent of period 1 change depends on • Cost of evidence k • whether pool of defendants seeking rule change includes bad as well as good defendants ( ) • Initial (exogenous) legal human capital • Information processing

15. Comparing legal regimes: Proposition 7 Suppose and the mix of defendants seeking rule change in two regimes, A and B, is the same. Then, ceteris paribus, if any of the following conditions hold:

16. Comparing legal regimes: Proposition 8 Suppose and the mix of defendants seeking rule change in two regimes, A and B, is the same. Then, ceteris paribus, period 2 rule change will be justified under a wider range of circumstances and lead to higher total social welfare in A under any of the following conditions:

17. Bad defendants and disinformation Investments by bad defendants as well as good may improve social welfare if informative • If lower risk of type 2 error encourages, or at least does not dissuade, judges to allow argument Proposition 9: Suppose both good and bad defendants proffer in regime B and only good proffer in regime A. Then

18. Conclusions • Five institutional parameters that matter • Distribution of judicial rewards for rule-adaptation • Cost of producing evidence & legal argument • Level of damages • Exogenous legal human capital/judicial error • Judicial information processing • Abstracting from judicial agency (corruption)

19. Conclusions • Legal human capital accumulation important • Can be excessive • Institutions matter • Judicial incentives • Who is the audience? What criteria? What information? • Judicial background/training • Practical versus formal education • Systemic information sharing • What is published? What detail? • Legal costs relative to damages • How competitive is market for lawyers? • What restrictions on size and specialization?

20. Common law v civil code debate “Common law” versus “civil code” is wrong question • Intra-category differences • Empirical studies and policy recommendations should look to more refined institutional attributes