Legal Design and the Production of Law

1. Legal Design and the Production of Law Gillian K. Hadfield University of Southern California ESNIE 2008

2. Framing the problem of legal design • Legal design: institutional/organizational structure of “rule” production and implementation • Courts, legislatures, legal profession . . . • Distinguish “efficient rule” analysis • Distinguish jurisprudence/moral theory • Legal inputs as products • How are they/should they be produced, priced, distributed and invented? • Differentiated spheres/functions with different positive/behavioral and normative considerations • Political/democratic • Economic/market

3. Framing the problem of legal design • Decentralized organic processes (evolution) • Endogeneity of legal production to legal implementation/use • Problems of agency/incentives • What is the impact of private incentives on achievement of socially optimal rules (corruption, lobbying, etc.)? • Problems of knowledge/information • How do legal institutions & actors ‘learn’ and adapt rules?

4. How is law produced? • Conventionally: by the state • Legislation (constitutions, statutes, codes) • Agency regulation • Courts (‘judge-made’ law, doctrine) • “Non-law” substitutes • Goals of coordination, commitment, risk allocation, distribution… • ‘Law’ as means not ends • Reputation, technology, social norms, organization • Private (market) third-party producers • Trade association (Bernstein 1992, 2001) • Stock exchanges (Macey & O’Hara 1999) • Internet (Hadfield 2004) • Private Law Inc? (Hadfield & Talley 2007, Hadfield 2008)

5. Example • Franchise contract Rule: Parties to a contract must perform in good faith • Source? • Code/statute obligation • Common law implied term • “Private Contracting Inc” • Function? • Commitment, risk allocation, bounded rationality, contracting cost reduction…. • Non-law substitutes? • Reputation • Norms/community sanctions • Organization (change actor, information) • Technology (change choice set, information)

6. Common law versus statute law “The efficiency of the common law” (Posner 1977: empirical claim) • Mechanism? • Judicial preferences (Posner 1977) • Insulation from lobbying/capture (Rubin 1978) • Litigation/settlement incentives (Priest 1978, Cooter Kornhauser & Lane 1979) • Superior ex post information (Gennaioli Shleifer 2007, Shavell 2007) • Rules versus standards (Diver (1983), Rose, Kaplow) • Learning • Issues? • Biasedevolution (path dependence of information set available to courts) (Hadfield 1992) • Judicial bias (Gennaioli Shleifer 2007) • Asymmetric stakes (repeat versus one-shot players) (Galanter 1974)

7. Common law versus civil code • Empirical claim (LLSV 1997, 1998, 2004; Djankov et al 2002, 2003, Botero 2004) • “English origin legal regimes/common law systems produce better law/economic growth than German, Scandinavian and French origin/civil code regimes” • Source of law—code versus judge-made • Theory • Insulation from politics (judicial independence, juries) (Glaeser & Shleifer 2001, Mahoney 2001, Feld & Voigt 2003) • Protection of contract/property rights from state • Ex post information (Anderlini Felli & Riboni 2007) • static • Adaptability/learning (Johnson 2000, Beck et al 2003) • dynamic

8. 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. 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 William Easterly, The White Man’s Burden (2006)

9. What’s wrong with this picture? • Mechanisms under-theorized • Information structures missing • Judicial incentives to adapt not analyzed • Comparative institutional content thin • Behavior treated as institution Common law = judicial independence Civil code = legislative control • All rules must be interpreted and applied case-by-case • All judges have (in theory) discretion • Research challenges • Distinguish behavior & institutions • Model judicial incentives, learning and adaptation of law • Identify institutional parameters

10. Levers of Legal Design (2008) Model Two periods, N judges, N defendant, N plaintiffs R : Period 1 existing rule: All defendants liable, damages D R′ : “Good” defendants should not be liable (socially optimal) How does system ‘learn’ new rule? k : evidence/argument cost of rule change Defendant incentives to invest γ : Judicial reward for rule-following α(i) : Judicial reward for accurate rule-adaptation 0 : Judicial reward for erroneous rule-adaptation Judicial incentives socially aligned Judges differ in perceived reward σ (1) : probability of type 1 error σ (2) : probability of type 2 error Ex ante limited judicial competence

11. Information production • Defendants seek ‘permission’ to present evidence/argument for rule change • Judge’s incentive to consider rule change depends on γ, α(i), σ (1) and σ (2) • Defendants’ incentives to seek rule change and invest in evidence/argument depend on their type, k, D, σ (1) and σ (2) • None invest if k/D too high • Only good types invest if k/D intermediate • Good and bad types invest if k/D low • Rule change requires both judge and defendant to choose risky/costly action in period 1

12. Linking time: Legal human capital Systemic errors σ (1) and σ (2) determined by shared legal human capital (K(t)) Legal human capital determined by (initial) exogenous factors and endogenous information processing • extent to which case specific learning shared with other judges K(2) = K(1) + i(Δ) • System can be ‘stuck’ at sub-optimal rule (no learning) because of • Too few judges rewarded for rule change OR • Legal costs relative to damages too high (no investment) or too low (too many bad defendants, judges won’t risk it) OR • Initial judicial error too high/legal human capital too low

13. Optimal rule change • Optimality of rule change depends on cost & error rates • If rule change optimal period 1: higher social welfare if • Lower legal costs • Higher damages • More effective information processing • Higher/more widespread judicial rewards • Higher initial legal human capital • If rule change not optimal period 1 but potentially period 2: • higher social welfare if • Lower legal costs • Higher damages • More effective information processing • Higher judicial rewards/initial legal human capital impact ambiguous • Increases value of period 2 change BUT • Can lead to excessive rule change period 1 • Problem of optimal capital growth

14. Institutional parameters • Costs of legal services/inputs • Damages • (Distribution of )judicial rewards for rule adaptation • Exogenous legal human capital (judicial error) • Information processing (sharing) What institutions determine these parameters?

15. Institutional Dimensions of Legal Regimes • Judicial careers • Career versus capstone judiciary • Court specialization • Information distribution • Explication (reasons, findings) • Publication • Identification of judge • Procedure • Single versus sequential decisions (event trial versus multiple hearings) • Issue shaping, evidence selection (power of judge, litigants) • Number of trial judges (panels, examining judges, single trial judge) • Public versus private enforcement of orders • Markets for legal services • Regulation • Training • Advertising • Organizational restrictions (Partnership? Employment?)

16. Linking institutions to parameters • Judicial rewards (α(j)) • Judicial audience determined by structure of judiciary • Senior judges v. ‘public’ • Different preferences & information (homogeneous versus heterogeneous) • Vulnerability to punishment for ‘error’ (exit options) • Specialization • Expert peer evaluation (senior judges, law professors) • Homogeneous • Information distribution • Publication of judicial identity: public attribution of performance • Evaluation of reasons, findings • Procedure • Judicial identification with decision • Judicial control over fact-finding (panels, examining judge, appeal)

17. Linking institutions to parameters • Exogenous legal human capital (K) • Structure of judiciary • Practical experience versus formal training • Age/experience on entry • Specialization in field • Embedded expertise in code/statute

18. Linking institutions to parameters • Information processing (i(Δ)) • Structure of judiciary • Analytical versus practical knowledge • Court specialization • Extent and publication of reasons, findings • Quantity • Quality (commentary) • Procedure • Volume of information (discovery, evidentiary rules) • Retention of raw information versus processed (examining judge) • Elimination or preservation of issues (trial, hearings, cross-examination, jury) • Judicial capacity to seek evidence (verification, overcome bias) • Legal markets • Expertise

19. Linking institutions to parameters • Legal costs (k) • Judicial careers, court specialization • Expertise, incremental information needed • Information distribution • Larger stock of information (reduced incremental cost) • Complexity • Procedure • Costly discovery, issue preservation • Excess ‘bad’ information • Public subsidy (judicial investigation) • Markets for lawyers (Hadfield 2000)

20. Institutional attributes of “legal families”

21. “Common law” versus “civil code” revisited • Empirical work based on theoretically meaningless (?) attribute (“code” or not) • Thin comparative knowledge of detailed institutions (parameters) • Intra-family variation • A priori generalization • “common law”: plentiful information, strong judicial incentives for change (public audience), lower exogenous legal expertise, higher factual expertise, expensive legal process & high complexity • “civil code”: limited information, weaker judicial incentives for change (professional audience), higher exogenous legal & area expertise, lower factual expertise, cheaper legal process, lower complexity

22. Who wins? Can’t say…yet • Comparative projects • analysis of detailed institutional attributes • Empirical projects • Institutional attributes as independent variables • Theory projects • Comparative quality of legislative/regulatory rule production process • Endogeneity of legal costs, complexity • Strategic interaction of litigants • Selection effects