Transaction costs as obstacles to ADR

Aristides N. HatzisAssociate Professor

Philosophy of Law & Theory of InstitutionsUniversity of Athens

Universität HamburgFebruary 6, 2015

Rising cost of litigation / Backlogged dockets

Lack of Expertise

Molière, Les Fourberies de Scapin (1671)Acte II, Scène V

Eh! Monsieur, de quoi parlez-vous là, et à quoi vous résolvez-vous? Jetez les yeux sur les détours de la justice; voyez combien d'appels et de degrés de juridiction, combien de procédures embarrassantes, combien d'animaux ravissants par les griffes desquels il vous faudra passer, sergents, procureurs, avocats, greffiers, substituts, rapporteurs, juges, et leurs clercs. Il n'y a pas un de tous ces gens-là qui, pour la moindre chose, ne soit capable de donner un soufflet au meilleur droit du monde. […] Eh! Monsieur, si vous le pouvez, sauvez-vous de cet enfer-là. C'est être damné dès ce monde que d'avoir à plaider, et la seule pensée d'un procès serait capable de me faire fuir jusqu'aux Indes. […] Mais, pour plaider, il vous faudra de l'argent: il vous en faudra pourl'exploit; il vous en faudra pour le contrôle; il vous en faudra pour la procuration, pour la présentation, conseils, productions, et journées du procureur; il vous en faudra pour les consultations et plaidoiries des avocats, pour le droit de retirer le sac, et pour les grosses d'écritures; il vous en faudra pour le rapport des substituts, pour les épices de conclusion, pour l'enregistrement du greffier, façon d'appointement, sentences et arrêts, contrôles, signatures, et expéditions de leurs clercs, sans parler de tous les présents qu'il vous faudra faire.

Bargaining is good

Every bargain, any negotiation that is based on consent will eventually lead to a mutually beneficial agreement if there is a surplus to be divided

Socially beneficial – efficient allocation of resources (Pareto, Posner/Marshall)

If there is no consent, the result of an arbitrary decision for transferring resources will be forced redistribution

Socially costly since the parties will spend resources to defend/influence the decision

Ronald Coase (1910-2013)

The reason why economists went wrong was that their theoretical system did not take into account a factor which is essential if one wishes to analyze the effect of a change in the law on the allocation of resources. This missing factor is the existence of transaction costs.

Shapiro & Pearse (2012)

Coase Theorem (the positive version)

The ultimate result (which maximizes the value of production) is independent of the legal position if the pricing system is assumed to work without cost. [...] With costless market transactions, the decision of the courts [...] would be without effect on the allocation of resources.

(Coase 1960)

I a “frictionless” world

It doesn’t matter if you go to court

Or if you prefer an ADR method of resolving a legal dispute

A court decision could be as efficient as a pre-trial agreement by the parties

Coase (1960)

This is of course, a very unrealistic assumption.

A world that doesn't really exist

When there are no costs of making transactions, it costs nothing to speed them up, so that eternity can be experienced in a split second.

It would not seem worthwhile to spend much time investigating the properties of such a world.

Coase (1988)

The Cost of Market Transactions

Once the costs of carrying out market transactions are taken into account, it is clear that such a rearrangement of rights will only be undertaken when the increase in the value of production consequent upon the rearrangement is greater than the costs which would be involved in bringing it about.

S > TC

The Problem of Social Cost (1960)

In order to carry out a market transaction, it is necessary to discover who it is that one wishes to deal with, to inform people that one wishes to deal and on what terms, to conduct negotiations leading up to a bargain, to draw up the contract, to undertake the inspection needed to make sure that the terms of the contract are being observed, and so on.

These operations are often extremely costly, sufficiently costly at any rate to prevent many transactions that would be carried out in a world in which the pricing system worked without cost.

Transaction Costs (the narrow version)

Search costInformation cost

Bargaining costEnforcement cost

Monitoring costs

TC in the broader sense

From the cost of market transactions(Coase)

To barriers to transactions (neo-institutional economics)

To cognitive obstacles in creating surpluses/increasing social welfare(behavioral economics)

Institutional Obstacles

Administrative costsSocial norms

Inefficient social normsAn adversarial cultureA culture where compromise is considered a sell-out, a defeat

Absence of efficient social normsTrust, reputation, business ethics, business practices

OverregulationCorruption

Social tolerance towards corruption

Rent-seeking

The 2011 Legatum Prosperity IndexVery low community engagement and low levels of trust result in

weak social ties in Greece

In a 2009 survey, only 16% of respondents felt they could trust others, and fewer than 28% had helped a stranger in the month before a 2010 survey, ranking Greece 107th, on the latter variable.

Levels of community engagement are generally low, with only 7% making a financial donation to charity in that time period, and only 3% volunteering their time. This places Greece in the lowest two countries of the Index for these variables.

Social networks are mediocre, as 87% of people feel they can rely on family and friends in times of need, placing Greece 54th on this variable. According to the same 2010 survey, just 32% of respondents had visited a place of worship in the previous seven days, indicating below global average access to religious networks.

However, a slightly above average marriage rate, of 64%, indicates greater access to familial networks.

Other obstacles

OpportunismStrategic behaviorMarket power / unequal bargaining powerCoordination cost

Cognitive TC

Endowment effect: people ascribe more value to things merely because they own themWealth effectOveroptimismHyberbolic discountingInequity aversionPath-dependency / Herd BehaviorSunk-cost fallacyLoss aversionCognitive dissonance / Adaptive preferences

Cognitive TC

Endowment effect

Wealth effect: people are not interested in a small surplus in comparison with their perceived wealthOveroptimismHyberbolic discountingInequity aversionPath-dependency / Herd BehaviorSunk-cost fallacyLoss aversionCognitive dissonance / Adaptive preferences

Cognitive TC

Endowment effectWealth effect

Overoptimism: people believe that they are less at risk of experiencing a negative event compared to othersHyberbolic discountingInequity aversionPath-dependency / Herd BehaviorSunk-cost fallacyLoss aversionCognitive dissonance / Adaptive preferences

Cognitive TC

Endowment effectWealth effectOveroptimism

Hyberbolic discounting: people show a preference for a reward that arrives sooner rather than laterInequity aversionPath-dependency / Herd BehaviorSunk-cost fallacyLoss aversionCognitive dissonance / Adaptive preferences

Cognitive TC

Endowment effectWealth effectOveroptimismHyberbolic discounting

Inequity aversion: people prefer an outcome they see as fair and resist to an outcome they see as unequalPath-dependency / Herd BehaviorSunk-cost fallacyLoss aversionCognitive dissonance / Adaptive preferences

Cognitive TC

Endowment effectWealth effectOveroptimismHyberbolic discountingInequity aversion

Path-dependency / Herd Behavior / Sunk-cost fallacy: people are influenced by past decisions, by the decisions of othersLoss aversionCognitive dissonance / Adaptive preferences

Cognitive TC

Endowment effectWealth effectOveroptimismHyberbolic discountingInequity aversionPath-dependency / Herd BehaviorSunk-cost fallacy

Loss aversion: people strongly prefer to avoid losses than to acquire gainsCognitive dissonance / Adaptive preferences:

Cognitive TCEndowment effectWealth effectOveroptimismHyberbolic discountingInequity aversionPath-dependency / Herd Behavior / Sunk-cost fallacyLoss aversion

Cognitive dissonance / Adaptive preferences: discomfort experienced with new information that conflicts with existing beliefs, ideas, or values

Thank you!Thank you!

ahatzis@phs.uoa.gr

http://www.phs.uoa.gr/ahatzis