Formalization Institutions: The Law of Impersonal Transactions—Meaning and Difficulties

1. Formalization Institutions: The Law of Impersonal Transactions—Meaning and Difficulties Building Market Institutions: Property Rights, Business Formalization and Economic Development University of Chicago Press, 2010 Benito ARRUÑADAPompeu Fabra University ISNIE 13th Annual ConferenceUC Berkeley, June 19, 2009

2. Outline • The problem of impersonal exchange • Sequential exchange • The contract formalization solution: • Efficiently diluting property rights • Prevalence of ‘sequential’ exchange • Consequences & difficulties: • E.g., rules are not enough & luddite lawyers

3. 1. The problem

4. Impersonal exchange of “lemons”

6. Sequential exchange: property rights vs.transaction costs

7. The judge’s dilemma: The tradeoff of property versus liability rules • Property rule: No one deprived without consent • Provides better enforcement: Consent of right holder required for a right to be damaged, but • increases information asymmetry b/c title uncertainty deters acquirers because rights survive • Liability rule: Protects less informed party • Reduces transaction costs, but • provides bad enforcement b/c consent not required • Goal: Overcoming this tradeoff, achieving both good enforcement and low transactions costs

8. 2. The solution

9. Organized (voluntary, verifiable) dilution of property rights • Liability rule—as in, e.g., Merchant Law: • Ruling for third party makes information asymmetry irrelevant • Property rule conditioned to publicity: e.g., real property • Publicity makes information asymmetry manageable • Registration makes it irrelevant • Preserving a role for consent keeps the enforcement advantage of property rights • Consent in choosing agent and activating liability rule • Consent in recording or registering • Independent intervention ex ante: • Commitment  Avoids opportunistic choice of rules ex post by P • Publicity  Obviates information asymmetry to T

10. 3. Cases: The prevalence of “sequential” exchange

11. Business transactions

12. Employee E harms T non-contractually

13. Borrowing by a hidden LLP

14. Sale of new shares

15. Company representation

16. Real property and ‘secured’ transactions

17. Double sale of land

18. Second mortgage

19. Two types of solution

21. Informal publicity & formalization

22. 4. Consequences & interpretation

23. Conclusions • Legal title the key info asymmetry for institutions • Property, in rem, rights key for impersonal trade • Overcoming tradeoff b/w property and transaction costs requires more than rules: organization • Verifiable publicity of originative contracts • Independence from parties to the originative contract

24. Why is it so hard to develop these market-enabling institutions? • Tortuous development • Liability is the default rule of impersonal trade • Commerce since 11th century • Corporate limitations not applied against third parties • Property titling moves into registration • But delayed +10 centuries, with awkward exceptions, failed in developing registers (US mess, Peru, etc). • Path-dependency: law developed for personal exchange  Luddite conflict: • Artisan jurists defending rents and using pre-market concepts • But the competing industry is… a public bureaucracy

25. Thanks