Contracting in the presence of judicial agency

Contract theory delves into designing mechanisms to motivate economic agents to act in ways that may not align with their immediate interests. These mechanisms require enforcement, and often this role is taken up by a judge in modern economies. Despite the focus on incentive problems, little attention has been directed towards the incentives of the contract enforcer, typically a judge. Prevailing among contract theorists has been the assumption that judges unfailingly enforce contracts as intended. This paper challenges this assumption by introducing the possibility that judges might not behave perfectly. It presents a variation of the standard principal-agent model in which a judge can, at a cost, accept bribes to refrain from enforcing a contract.

The core argument of this paper is that anticipating potential exploitation after the fact, parties involved in contracts will react to the agency of the judge by curtailing the authority they confer to the judge beforehand. This means they might refrain from entering contracts altogether and/or exclude certain contingencies from the contract to prevent a judge from extorting bribes later by manipulating how these contingencies are enforced. This phenomenon becomes more pronounced when the need for incentivizing the agent is high and when corruption is more prevalent within the judiciary. Additionally, since corruption is harder to detect in situations requiring significant judicial interpretation, contracts tied to intricately specified circumstances will be more challenging to formulate.

Many legal histories suggest that judicial agency was a significant occurrence historically. Both anecdotal and survey evidence indicate that it remains widespread in developing countries today. I will also discuss some contemporary instances of judicial agency in the U.S. Furthermore, while I will often discuss judges accepting bribes, the formal model closely relates to a scenario where contracting parties hire lawyers to represent them. The more resources spent on legal representation, the higher the likelihood of winning a case, regardless of its merits (as explored in subsection 3.6 below).