Optimal delegation and decoupling in the design of liability rules

Michigan Law Review

Volumn 100, Issue 1, 2001, Pages 1-79

  Ayres, Ian ^b   Goldbart, Paul M ^a  

^a University of Illinois at Urbana Champaign   (United States)

^b NONE

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EID: 0041348973     PISSN: 00262234     EISSN: None     Source Type: Journal    
DOI: 10.2307/1290404     Document Type: Article

References (189)

1. Guido Calabresi & Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 HARV. L. REV. 1089 (1972).
2. Property rules also often protect entitlements from intentional takings, while liability rules protect them from negligent takings. Hence, you commit a criminal offense if you intentionally break your neighbor's arm (i.e., a property rule protects the integrity of her arm with regard to your intentional taking), but you owe your neighbor compensatory damages if you break her arm through mere negligence (i.e., a liability rule protects the integrity of her arm with regard to your negligent taking).
3. Like Calabresi and Melamed, see Calabresi & Melamed, supra note 1, at 1091-93, we use the term "initial" entitlement to convey the idea that, because of the possibility of a subsequent taking, the ultimate entitlement to control whether or not pollution will take place may belong to a taker.
4. Rule 1, for example, represents a decision in which the court grants the initial entitlement to the Resident and protects it with a property rule. This deters the Polluter, with the threat of contempt of court, from taking the entitlement nonconscnsually. In contrast, Rule 2 awards the initial entitlement to the Resident but protects it only with a less stringent, compensation-based liability rule under which the Polluter still might nonconsensually take the Resident's entitlement but pay compensatory damages for doing so. Rule 2 was famously deployed in Boomer v. Atlantic Cement Co., 257 N.E.2D 870, 875 (N.Y. 1970). Finally, Rule 3 finds the pollution not to be a nuisance at all, thereby effectively giving the initial entitlement to continue polluting freely to the Polluter under a property rule.
5. In a recent symposium honoring the twenty-fifth anniversary of One View of the Cathedral, Symposium, Property Rules, Liability Rules, and Inalienability: A Twenty-Five Year Retrospective, 106 YALE L.J. 2083-2213 (1997), Calabresi pointed out that James Atwood had discussed the possibility of a Rule 4-like outcome in a student note that he published in the Stanford Law Review three years before Calabresi and Melamed's analysis. See Guido Calabresi. Remarks: The Simple Virtues of the Cathedral, 106 YALE L.J. 2201, 2204 (1997) (citing James R. Atwood, Note, An Economic Analysis of Land Use Conflicts, 21 STAN. L. REV. 293, 315 (1969)).
6. In a recent symposium honoring the twenty-fifth anniversary of One View of the Cathedral, Symposium, Property Rules, Liability Rules, and Inalienability: A Twenty-Five Year Retrospective, 106 YALE L.J. 2083-2213 (1997), Calabresi pointed out that James Atwood had discussed the possibility of a Rule 4-like outcome in a student note that he published in the Stanford Law Review three years before Calabresi and Melamed's analysis. See Guido Calabresi. Remarks: The Simple Virtues of the Cathedral, 106 YALE L.J. 2201, 2204 (1997) (citing James R. Atwood, Note, An Economic Analysis of Land Use Conflicts, 21 STAN. L. REV. 293, 315 (1969)).
7. In a recent symposium honoring the twenty-fifth anniversary of One View of the Cathedral, Symposium, Property Rules, Liability Rules, and Inalienability: A Twenty-Five Year Retrospective, 106 YALE L.J. 2083-2213 (1997), Calabresi pointed out that James Atwood had discussed the possibility of a Rule 4-like outcome in a student note that he published in the Stanford Law Review three years before Calabresi and Melamed's analysis. See Guido Calabresi. Remarks: The Simple Virtues of the Cathedral, 106 YALE L.J. 2201, 2204 (1997) (citing James R. Atwood, Note, An Economic Analysis of Land Use Conflicts, 21 STAN. L. REV. 293, 315 (1969)).
8. Spur Indus., Inc. v. Del E. Webb Dev. Co., 494 P.2d 700, 708 (Ariz. 1972) (Cameron, V.C.J.). The court's unconditional order seems different than the definition of Rule 4 in the text, which gives the Resident the choice of whether (a) to pay to stop further pollution or (b) not to pay and to allow the Polluter to continue polluting. To harmonize the case with the definition, we must speculate about what would have happened if Del Webb (the developer representing the Residents) had petitioned to void the court order enjoining the pollution as well as the order that Del Webb indemnify Spur (the Polluter). If we believe that the court would have allowed Del Webb to withdraw its initial complaint and thereby void the consequent court orders, it would have in effect given Del Webb the Rule 4 choice - that is, the choice to pay to stop the pollution or not to pay and allow the pollution to continue. At a minimum, future developers will at least realize that suing in this jurisdiction may in effect be choosing to pay for an injunction.
9. Indeed, probably a dozen other articles aver, in one way or another, to this history. See, e.g., Robert C. Ellickson, Alternatives to Zoning: Covenants, Nuisance Rules and Fines as Land Use Controls, 40 U. CHI. L. REV. 681 (1973); James E. Krier & Stewart J. Schwab, Property Rules and Liability Rules: The Cathedral in Another Light, 70 N.Y.U. L. REV. 440, 442 (1995).
10. Indeed, probably a dozen other articles aver, in one way or another, to this history. See, e.g., Robert C. Ellickson, Alternatives to Zoning: Covenants, Nuisance Rules and Fines as Land Use Controls, 40 U. CHI. L. REV. 681 (1973); James E. Krier & Stewart J. Schwab, Property Rules and Liability Rules: The Cathedral in Another Light, 70 N.Y.U. L. REV. 440, 442 (1995).
11. Madeline Morris, The Structure of Entitlements, 78 CORNELL L. REV. 822, 854-56 (1993).
12. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
13. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
14. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
15. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
16. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
17. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
18. See, e.g., Ian Ayres, The 1998 Monsanto Lecture: Protecting Property with Puts, 32 VAL. U. L. REV. 793 (1998); Ian Ayres & J.M. Balkin, Legal Entitlements as Auctions: Property Rules, Liability Rules, and Beyond, 106 YALE L.J. 703, 729-33 (1996); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995); Richard Epstein, A Clear View of The Cathedral: The Dominance of Property Rules, 106 YALE L.J. 2091, 2093 (1997); Krier & Schwab, supra note 7, at 470-75; Saul Levmore, Unifying Remedies: Property Rules, Liability Rules, and Startling Rules, 106 YALE L.J. 2149 (1997); Carol M. Rose, The Shadow of The Cathedral, 106 YALE L.J. 2175 (1997) (referring to this feature of liability rules as simply an "option").
19. Property rules (Rules 1 and 3) can also fit easily into a call-option framework: the only difference between a property rule and a liability rule is the difference in the potential taker's exercise price. Property rules set the exercise price so high that no option holder would choose to exercise the option. See Ayres & Talley, supra note 9, at 1048.
20. 257 N.E.2d 870, 875 (N.Y. 1970).
21. 494 P.2d 700, 708 (Ariz. 1972).
22. Some authors have reversed the labels of Rules 5 and 6. See, e.g., Ayres, supra note 9, at 797 n.9; Levmore, supra note 9, at 2163.
23. Ayres, supra note 9, at 800.
24. See Ayres, supra note 9; Louis Kaplow & Steven Shavell, Property Rules Versus Liability Rules: An Economic Analysis, 109 HARV. L. REV. 713, 719 (1996).
25. See Ayres, supra note 9; Louis Kaplow & Steven Shavell, Property Rules Versus Liability Rules: An Economic Analysis, 109 HARV. L. REV. 713, 719 (1996).
26. See Ayres, supra note 9, at 801-13; Krier & Schwab, supra note 7; Levmore, supra note 9, at 2168-72.
27. RESTATEMENT (SECOND) OF TORTS § 826(a) (1979).
28. See discussion infra Section I.B.
29. For recent discussions on the separate and important question of whether and under what conditions liability rules dominate (or are dominated by) property rules, see Ayres & Talley, supra note 9; Ian Ayres & Eric Talley, Distinguishing Between Consensual and Nonconsensual Advantages of Liability Rules, 105 YALE L.J. 235 (1995) [hereinafter Consensual and Nonconsensual Advantages]; Epstein, supra note 9; Kaplow & Shavell, supra note 15; and Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221 (1995) [hereinafter A Reply to Ayres and Talley]. In the Conclusion, we return to this issue and show how our analysis also informs our understanding of when property rules will likely dominate liability rules. See infra notes 159-164 and accompanying text.
30. For recent discussions on the separate and important question of whether and under what conditions liability rules dominate (or are dominated by) property rules, see Ayres & Talley, supra note 9; Ian Ayres & Eric Talley, Distinguishing Between Consensual and Nonconsensual Advantages of Liability Rules, 105 YALE L.J. 235 (1995) [hereinafter Consensual and Nonconsensual Advantages]; Epstein, supra note 9; Kaplow & Shavell, supra note 15; and Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221 (1995) [hereinafter A Reply to Ayres and Talley]. In the Conclusion, we return to this issue and show how our analysis also informs our understanding of when property rules will likely dominate liability rules. See infra notes 159-164 and accompanying text.
31. For recent discussions on the separate and important question of whether and under what conditions liability rules dominate (or are dominated by) property rules, see Ayres & Talley, supra note 9; Ian Ayres & Eric Talley, Distinguishing Between Consensual and Nonconsensual Advantages of Liability Rules, 105 YALE L.J. 235 (1995) [hereinafter Consensual and Nonconsensual Advantages]; Epstein, supra note 9; Kaplow & Shavell, supra note 15; and Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221 (1995) [hereinafter A Reply to Ayres and Talley]. In the Conclusion, we return to this issue and show how our analysis also informs our understanding of when property rules will likely dominate liability rules. See infra notes 159-164 and accompanying text.
32. For recent discussions on the separate and important question of whether and under what conditions liability rules dominate (or are dominated by) property rules, see Ayres & Talley, supra note 9; Ian Ayres & Eric Talley, Distinguishing Between Consensual and Nonconsensual Advantages of Liability Rules, 105 YALE L.J. 235 (1995) [hereinafter Consensual and Nonconsensual Advantages]; Epstein, supra note 9; Kaplow & Shavell, supra note 15; and Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221 (1995) [hereinafter A Reply to Ayres and Talley]. In the Conclusion, we return to this issue and show how our analysis also informs our understanding of when property rules will likely dominate liability rules. See infra notes 159-164 and accompanying text.
33. For recent discussions on the separate and important question of whether and under what conditions liability rules dominate (or are dominated by) property rules, see Ayres & Talley, supra note 9; Ian Ayres & Eric Talley, Distinguishing Between Consensual and Nonconsensual Advantages of Liability Rules, 105 YALE L.J. 235 (1995) [hereinafter Consensual and Nonconsensual Advantages]; Epstein, supra note 9; Kaplow & Shavell, supra note 15; and Louis Kaplow & Steven Shavell, Do Liability Rules Facilitate Bargaining? A Reply to Ayres and Talley, 105 YALE L.J. 221 (1995) [hereinafter A Reply to Ayres and Talley]. In the Conclusion, we return to this issue and show how our analysis also informs our understanding of when property rules will likely dominate liability rules. See infra notes 159-164 and accompanying text.
34. Under Rule 2 as applied to our Resident and Polluter example, the Polluter has the (call-option) choice either to pollute and pay damages or to refrain and pay nothing; under Rule 5 the Polluter has a (put-option) choice either to refrain from polluting and receive damages or to pollute and receive nothing. Under either rule, the Resident has no power to affect the ultimate allocation except by bargaining with the Polluter in the shadow of these defendant-choice rules.
35. Jack Balkin and Ian Ayres have previously analyzed second-order liability rules, which, like dual-chooser liability rules, give both litigants a voice in the ultimate allocation. See Ayres & Balkin, supra note 9. But unlike second-order (or higher) rules, which require successively higher exercise prices, the dual-chooser rules at the center of this Article concern a single set of exercise prices on which both litigants base their decisions. We compare and contrast dual-chooser rules and second-order rules more fully in Part III, infra.
36. Madeleine Morris mentions in passing the theoretical possibility of "dual-chooser," rules, but she does not identify circumstances when they might be advisable nor does she suggest the possibility of their existence in current legal practice. See Morris, supra note 8, at 854; see also Ayres, supra note 9, at 823-35 (discussing the possibility of such rules); RONEN AVRAHAM, MODULAR LIABILITY RULES, (John M. Olin Ctr. for Law & Econ., Univ. of Mich., Working Paper No. 01-003, 2001), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=272816 (addressing extensively the rationales for such rules).
37. Madeleine Morris mentions in passing the theoretical possibility of "dual-chooser," rules, but she does not identify circumstances when they might be advisable nor does she suggest the possibility of their existence in current legal practice. See Morris, supra note 8, at 854; see also Ayres, supra note 9, at 823-35 (discussing the possibility of such rules); RONEN AVRAHAM, MODULAR LIABILITY RULES, (John M. Olin Ctr. for Law & Econ., Univ. of Mich., Working Paper No. 01-003, 2001), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=272816 (addressing extensively the rationales for such rules).
38. See Kaplow & Shavell, supra note 15, at 725.
39. In this Article, we generally distinguish between "allocation" of the entitlement at hand and "distribution" of wealth or value.
40. Even after parties have produced evidence of their respective valuations, we imagine that courts will still have residual doubts about their true valuations. Some of these doubts may stem from inevitable uncertainties about the future (e.g., will the factory's new machine work?), while other doubts may simply result from the litigants' strategic incentive to misrepresent their valuations (e.g., "I really value this land because my dog is buried here").
41. Boomer v. Atlantic Cement Co., 257 N.E.2d 870, 875 (N.Y. 1970); Spur Indus., Inc. v. Del E. Webb Dev. Co., 494 P.2d 700, 708 (Ariz. 1972). James Krier and Stewart Schwab provided the best modern discussion of how courts should respond to numerosity problems in choosing among liability rules. See Krier & Schwab, supra note 7.
42. See, e.g., Copart Indus. v. Consolidated Edison Co., 362 N.E.2d 968 (N.Y. 1977) (pollution from ConEd plant disrupted adjacent new car preparation business): Estancias Dallas Corp. v. Shultz, 500 S.W.2d 217 (Tex. Ct. App. 1973) (air conditioner noise reduced value of single adjacent residence). The class of cases dealing with visual nuisances in particular tends to involve a single plaintiff and a single defendant. See, e.g., Fontainebleau Hotel Corp. v. Forty-Five Twenty-Five, Inc., 114 So.2d 357 (Fla. Ct. App. 1959) (hotel addition obstructed view of adjacent hotel); Amphitheaters, Inc. v. Portland Meadows, 198 P.2d 847 (Or. 1948) (light from night-time dog track interfered with adjacent drive-in movie).
43. Rose characteristically hits the nail on the head when she explains that: "Ayres [is] interested in situations in which two parties are stuck with each other, 'thin' markets instead of 'thick' ones. Neighboring landowners seem to fit that bill." Rose, supra note 9, at 2183.
44. See Ward Farnsworth, Do Parties to Nuisance Cases Bargain After Judgment? A Glimpse Inside the Cathedral, 66 U. CHI. L. REV. 373 (1999).
45. See A Reply to Ayres and Talley, supra note 19, at 228-29. The persistence conjecture predicts that a liability rule that has a nonconsensual efficiency advantage under conditions of autarky (i.e., high bargaining costs) will continue under the conditions of low bargaining costs. According to Kaplow and Shavell, headstarts from nonconsensual efficiency will tend to persist when bargaining becomes possible. Id. While not denying a persistence effect, however, we believe that different liability rules themselves can induce different types of information disclosure and thereby affect the relative efficiency of rules independent of the autarkic or nonconsensual effect on allocative efficiency. See Consensual and Nonconsensual Advantages, supra note 19.
46. With regard to visual nuisances, however, correlated valuations occur more frequently. For example, new structures often derive much of their value from the good views they obstruct. See, e.g., Fontainebleau Hotel, 114 So. 2d at 357.
47. See infra notes 167-169 and accompanying text.
48. Carol Rose has acutely observed that Ayres's previous option analysis has a contractual shadow as its paradigmatic example: "The contractual relationship has only a discrete number of parties - paradigmatically two - who . . . are stuck with each other." Rose, supra note 9, at 2187. Rose is clearly right that contractual renegotiations often involve limited numbers and a bilateral monopoly.
49. See Ayres & Balkin, supra note 9, at 745. While contract renegotiations may serve as a paradigmatic case of bilateral monopoly, however, other examples exist.
50. See Ayres & Balkin, supra note 9.
51. Rose, supra note 9, at 2178-79. See generally Ayres & Talley, supra note 9, at 1062-65 (discussing dimensions into which courts might divide an entitlement, including put and call divisions).
52. Hohfeld long ago recognized that rights are relational. See Wesley Newcomb Hohfeld, Fundamental Legal Conceptions as Applied in Judicial Reasoning, 26 YALE L.J. 710 (1917); Wesley Newcomb Hohfeld, Some Fundamental Legal Conceptions as Applied in Judicial Reasoning, 23 YALE L.J. 16 (1913). One's right (or entitlement) simultaneously imposes an obligation (or liability) on someone else. The sum of put and call options in any row of Table 1 equals zero, reflecting this Hohfeldian concept.
53. Hohfeld long ago recognized that rights are relational. See Wesley Newcomb Hohfeld, Fundamental Legal Conceptions as Applied in Judicial Reasoning, 26 YALE L.J. 710 (1917); Wesley Newcomb Hohfeld, Some Fundamental Legal Conceptions as Applied in Judicial Reasoning, 23 YALE L.J. 16 (1913). One's right (or entitlement) simultaneously imposes an obligation (or liability) on someone else. The sum of put and call options in any row of Table 1 equals zero, reflecting this Hohfeldian concept.
54. Viewing liability rules as "derivatively" dividing the claims to an entitlement makes explicit the idea that changing the type of "protection" for an entitlement also actually changes the content of the entitlement. See Jules L. Coleman & Jody Kraus, Rethinking the Theory of Legal Rights, 95 YALE L.J. 1335, 1338-39 (1986). Viewing liability rules as merely asset divisions also calls into question Richard Epstein's claim about the superiority of "property rules." Because property rules also protect both the PRSTO and the call option themselves, see Ayres & Balkin, supra note 9, at 707, Epstein's claim must relate not just to how to protect entitlements but also to how to bundle collections of strongly protected claims together.
55. See discussion infra Section IV.E.
56. An Appendix available from the authors proves this proposition.
57. Δ = D, the defendant will be indifferent as to whether it exercises either its put or its call options. How the defendant acts on this indifference, however, will not affect the expected total payoffs for each litigant. The inequalities in the text implicitly assume that the defendant's willingness to pay equals its willingness to accept. But see Ayres, supra note 9 and infra Section IV.E for a discussion of why this assumption might not hold.
58. The payoffs of individual litigants merely equal their valuation of the entitlement should they ultimately receive it, net of any side payments that they make to or receive from the opposing litigants. Because the sum of the side payments must equal zero, the total payoffs for the plaintiff and defendant simply equal the value ascribed to the entitlement by the litigant who ultimately owns it.
59. Note the parallel to the Coase Theorem. In a world without transaction costs, the judicial assignment of entitlements does not affect the allocative equilibrium but does affect the distribution of payoffs. Likewise, an autarkic model of liability rules, where high transaction costs make bargaining prohibitive, can produce a similar result. Ayres and Balkin demonstrated that liability rules form a kind of auction mechanism that would mimic the results of Coasean negotiations. See Ayres & Balkin, supra note 9, at 727-29.
60. For example, if the plaintiffs and defendants valuations are independently and uniformly distributed between $0 and $100, and if damages are set equal to $50 (which we later show is the optimal amount), then Rule 5 will yield an expected defendant payoff of $62.50, while Rule 2 will yield the defendant only $12.50. See Ayres, supra note 9, at 806.
61. See Kaplow & Shavell, supra note 15 (deriving this result with regard to call-option Rules 2 and 4).
62. If the distributions do correlate, courts should still set the optimal single-chooser rule damages at the nonchooser's mean value - but because this mean value now occurs as a function of the chooser's value, optimal damages will occur at the fixed point at which damages equal both the nonchooser's value and the chooser's value. See discussion infra Section IV.F.
63. As discussed in the next section. Section I.C, infra, the single-chooser rules give the nonchoosers a fixed expected payoff whether or not the choosers exercise their options. For example, under Rule 2, the plaintiffs as nonchoosers receive an expected value equal to their mean valuations if defendants do not exercise their call options because plaintiffs will retain the entitlements. On the other hand, plaintiffs will receive their expected valuations in cash if defendants do exercise their call options and pay damages set equal to plaintiffs' expected valuations. Fixing the nonchoosers' expected payoffs makes choosers the residual claimants of gains arising from exercise of their options. The nonchoosers resemble bondholders in corporate law who are fixed claimants on the assets of the firm, while choosers resemble the shareholders who hold the residual claims. Because choosers internalize all the marginal effects of their choice, single-chooser rules give them, like the shareholders in corporate law, incentives to choose the allocation that maximizes allocative efficiency, conditional on their superior private knowledge.
64. Defendants under Rule 2 will choose to pollute and pay $50 only if their valuations exceed the plaintiffs' mean valuations; defendants under Rule 5 will forego payments of $50 only if their valuations exceed that amount.
65. See Krier & Schwab, supra note 7 (suggesting that the smaller, less numerous party makes the more efficient chooser). The concept of "efficient chooser" is an autarkic analog to the concept of the more "efficient briber," discussed originally by Calabresi & Hischoff. Guido Calabresi & John T. Hirschoff, Toward a Test for Strict Liability in Torts, 81 YALE L.J. 1055, 1060 (1972).
66. Appendix, supra note 40.
67. See RICHARD A. BREALEY & STEWART C. MYERS, PRINCIPLES OF CORPORATE FINANCE 557-59 (5th ed. 1996) (defining put-call parity); Ayres & Talley, supra note 9, at 1047 (applying put-call parity to liability rules). The put-call parity formula is often stated in the following form: Call + Exercise Price = Put + Underlying Asset. As applied to single-chooser rules, since the exercise price of the options is set equal to the nonchooser's mean value, the left-hand side of this equation equals the first expression (equation A) for the expected total payoff. And since the expected value of the underlying asset to the chooser is its mean, the right-hand side of this equation equals the second expression (equation B) for the expected total payoff.
68. Δ)" represents the expected value of a put option for a defendant when we set the exercise price of the put equal to the plaintiff's mean valuation.
69. We use the word "speculative" in a special sense. Our model assumes that each litigant places a non-speculative, certain dollar value on its ownership of the entitlement while the court and the adversaries must speculate (via a probability distribution) about how much the entitlement is valued by the litigant. But in many real-world contexts, however, the litigants themselves may not know precisely their own valuations. A polluter, for example, may also have to speculate about how much profit a polluting factory will yield in the future. We will later relax this assumption that litigants are perfectly informed about their own valuation, see infra Section IV.E, but for now it is sufficient to say that our core qualitative results go through. The more efficient chooser will continue to be the litigant with the larger informational advantage.
70. See Appendix, supra note 40.
71. See id. 56. From a court's perspective, a plaintiff whose mean valuation exceeds the defendant's mean valuation will more likely exercise a call option because more of the plaintiffs probability distribution will exceed the call's exercise price, which equals the defendant's mean. Similarly, the defendant will more likely exercise a put option because more of the defendant's probability distribution will fall below the put's exercise price, which equals the plaintiffs mean. In other words, the value of call or put options depends in part on the odds that the litigants will actually exercise them. The odds that litigants will exercise their options in turn lie in direct proportion to the odds that their own mean valuations fall above or below their opponents' mean valuations.
72. Δ)" to decrease.
73. We agree with Kaplow and Shavell that the speculative nature of damages should not exclude them from the court's assessment, see Kaplow & Shavell, supra note 15, at 728-32, but our approach simplifies the judicial task by requiring only an assessment of the less speculative litigant's average valuation.
74. See Ayres, supra note 9, at 812-13, 821 & n.81. For example, if the litigants' values are both uniformly distributed between $0 and $100, then a single-chooser rule will give the chooser a fixed amount 50% of the time and a $50 range of values the other 50% of the time, but the rule will give the nonchooser a fixed payoff 50% of the time and a $100 dollar range of values the other 50% of the time. We derive this more formally in the Appendix, supra note 40.
75. See Krier & Schwab, supra note 7, at 471-72.
76. See discussion infra Section IV.D.
77. In analyzing the distributive consequences of different rules, one must distinguish between two different informational perspectives. The ex ante perspective assesses the litigants' expected payoffs before they acquire information about their own valuation of the entitlement. The interim perspective assesses the litigants' expected payoffs after they identify their own valuations but before learning the other side's valuation. From the ex ante perspective, the possibility of facing the other side's put option does not produce a negative expected payoff. Under Rule 6, a Resident may force a Polluter to purchase the right to pollute, but if the court sets the price at the Polluter's expected valuation, the Polluter's expected payoff equals zero. In contrast, from the interim perspective, the possibility of facing to the other side's put option can produce a negative expected payoff if, for example, under Rule 6 a Polluter happens to have a lower than average valuation. The ex ante perspective also matches the perspective of the court in deciding how to divide the expected payoffs between sets of observationally equivalent litigants. This perspective may at times also bear relevance to the formation of efficient investment incentives, if the parties don't know their actualized valuation until after the court creates the entitlement. Nevertheless, the interim perspective will potentially drive both investment and allocation decisions in other contexts.
78. NC. Of course, once nonchoosers come to know their private value of the entitlement, they will not be indifferent about whether the chooser exercises its option or not. But the court (and other policy makers) will never be privy to this privately held information, so the best that a distributively concerned court can do is to adopt the type of implementation that tends, on average, to produce a preferred distribution.
79. Π).
80. Other authors have suggested a proliferation of liability rules on different grounds, see, e.g., Levmore, supra note 9, at 2171 (showing how liability rules could require different levels of negligence before taking), but, with our convexity result, we are the first to focus on distributive flexibility.
81. Opportunity cost corresponds to "the price that you pay for things that you might have done." Ian Ayres, Analyzing Stock Lock-Ups: Do Target Treasury Sales Foreclose or Facilitate Takeover Auctions?. 90 COLUM. L. REV. 682, 688 n.19 (1990) (quoting BILLY JOEL, Only the Good Die Young, on THE STRANGER (Columbia Records 1977)).
82. Opportunity cost corresponds to "the price that you pay for things that you might have done." Ian Ayres, Analyzing Stock Lock-Ups: Do Target Treasury Sales Foreclose or Facilitate Takeover Auctions?. 90 COLUM. L. REV. 682, 688 n.19 (1990) (quoting BILLY JOEL, Only the Good Die Young, on THE STRANGER (Columbia Records 1977)).
83. NC. 68. See discussion infra Section IV.E.
84. NC damages amounts up above the pay-or-pay or down below the put amounts.
85. See Ayres & Talley, supra note 9, at 1062-65; Rose, supra note 9, at 2178-79.
86. NC is setting two prices. Other law and economic scholars have considered decoupling the amount the defendant pays from the amount the plaintiff receives. See A. Mitchell Polinsky and Yeon-Koo Che, Decoupling Liability: Optimal Incentives for Care and Litigation, 22 RAND J. ECON. 562 (1991). The type of decoupling this Article proposes, however, differs because the side payments from the litigants always net to zero.
87. NC). Under the call implementation with the lump-sum mean side payment, plaintiffs would end up with (i) the entitlement and no net dollar transfer if they allocate the entitlement to themselves, or (ii) a net dollar transfer equaling the defendant's mean value, if plaintiffs allocate the entitlement to the defendant. This, of course, yields the same outcome as under the put implementation.
88. Cf. Boomer v. Atlantic Cement Co., 257 N.E.2d 870, 875 (N.Y. 1970). At some point, however, an additional increase in the exercise price of the defendant's call would not increase the plaintiff's expected payoff because the defendant would never agree to pay such a price.
89. See Ayres, supra note 9, at 807; Ayres & Balkin, supra note 9, at 733. The ex ante investment effects of traditional liability rules are explored by Lucian Arye Bebchuk, Property Rights and Liability Rules: The Ex Ante View of the Cathedral, 100 MICH. L. REV. (forthcoming Dec. 2001).
90. See Ayres, supra note 9, at 807; Ayres & Balkin, supra note 9, at 733. The ex ante investment effects of traditional liability rules are explored by Lucian Arye Bebchuk, Property Rights and Liability Rules: The Ex Ante View of the Cathedral, 100 MICH. L. REV. (forthcoming Dec. 2001).
91. D See supra notes 71-72 and accompanying text.
92. ΠP by initially putting, and the defendant can accept this offer by choosing not to put the entitlement back. In contrast, this footnote's double-call rule allows the defendant to offer to buy the entitlement by exercising its initial call option, and the plaintiff can accept this offer by choosing not to call the entitlement back. 77. The option interpretation of these dual-chooser rules makes clear that they are constrained versions of what one of us has previously referred to as "second-order rules." See Ayres & Balkin, supra note 9. The dual-chooser rules constrain these second-order rules by setting the exercise price of both options to an identical amount. $D. Part III, infra, of this Article analyzes and compares the unconstrained analog to this constrained, dual-chooser version.
93. The court may thereby force an encroacher not only to compensate the landowner for the temporary, past encroachment, but also to purchase a "permanent" right to encroach on the land in the future, even if the encroacher would actually prefer to remove the encroachment instead.
94. See Pile v. Pedrick, 31 A. 646, 647 (Pa. 1895) (granting plaintiff the choice of damages for "permanent trespass" or an injunction to remove the "offending ends of the stones," after finding that defendant's brick wall encroached one and three-eighths inches underneath the plaintiffs property).
95. Accordingly, we can apply a similar two-stage analysis to (i) a tenant's choice to hold over, followed by a landlord's choice to force an additional term lease, see JESSE DUKEMINIER & JAMES E. KRIER, PROPERTY 431 (3d. ed. 1993); RESTATEMENT (SECOND) OF PROPERTY: LANDLORD AND TENANT § 14.4 cmt. f (1977), or (ii) an intentional taking of chattel followed by the owner's choice of trover (i.e., compensatory damages) or replevin (i.e., an injunction ordering the chattel's return), see DUKEMINIER & KRIER, supra, at 105-06.
96. In contrast, it is usually possible to implement single chooser rules in which the defendant has the sole allocative choice. For example, the defendant's choice both to commence pollution and to exercise its call-option amount to a unitary decision to take the entitlement and pay damages. Of course, plaintiffs often make deliberate choices about whether to produce the entitlement in the first place - so the plaintiff's initial investment decision may introduce elements of plaintiff choice into what otherwise would be a defendant chooser rule. There may, however, also be some limits on the ability of courts to vary how the payoff is distributed. If polluting potentially exposes the polluter to a pay-or-pay allocation, then a polluter who will ultimately choose not to allocate the entitlement to itself will prefer not to pollute in the first place. See Levmore, supra note 9, at 2168-70 (discussing impact of expected damages on litigants' initial incentive to pollute or bring suit).
97. ΔP].
98. Δ.
99. See Ayres, supra note 9, at 827 (discussing possibility of a "joint-veto" regime with damages that "will approximately split the difference between the Resident's and the Polluter's mean valuations").
100. Π, which, when solved, yields D = $62.50.
101. Π + (1-α)EPΔ would distribute a fraction α of the joint expected payoff to the plaintiff and a fraction (1 - α) to the defendant.
102. Besides this "off-diagonal" effect, the two types of dual-chooser rules can produce different optimal damages, which might affect which equilibrium generates more allocative efficiency.
103. For example, when the litigants' valuations are uniformly distributed, a higher plaintiff mean implies that the plaintiff-presumption equilibrium wili produce a higher expected joint payoff than the defendant-presumption equilibrium.
104. Π, which when solved yields D = $90.00.
105. The forty-five degree diagonal line represents the first-best allocation, possible only with perfect information.
106. For example, for uncorrelated, uniform distributions it can be shown that when there is no mean difference but only a variance difference, the better single-chooser rule dominates the better dual-chooser rule and hence the better single-chooser rule is globally optimal (within the class of single-price liability rules). Conversely, when there is no variance difference, but only a mean difference, it can be shown that the better dual-chooser rule dominates the better single-chooser rule and hence the better dual-chooser rule is globally optimal.
107. The example can also be easily converted to show how a defendant-presumption rule can dominate any of the other three foundational allocations by simply reversing the identity of the plaintiff and defendant probability distributions - so that the plaintiff's value would be distributed uniformly between $0 and $100, and the defendant's value between $80 and $180.
108. This happens because the plaintiffs valuation ranges from $80 to $180 and thus will always exceed the $50 damage payment for allocating the entitlement to the defendant.
109. Likewise, this happens because the defendant's valuation ranges from $0 to $100 and thus the $130 damage payment for allocation to the plaintiff would always exceed the defendant's valuation.
110. See supra note 89 and accompanying text.
111. Expected joint profits under a plaintiff-presumption allocation equal $130.10, as compared to single-chooser joint profits of $130.00. When the single-chooser rules allocate the entitlement exclusively to one litigant, the dual-chooser rules can never produce a lower expected total payoff because we can set dual-chooser damages to produce an always nonnuanced equilibrium. For example, if the plaintiff-presumption damages were set at $130, then the defendant would always veto allocating the entitlement to itself.
112. Boomer v. Atlantic Cement Co., 257 N.E.2d 870, 875 (N.Y. 1970). Whalen v. Union Bag & Paper Co., 101 N.E. 805 (N.Y. 1913), also provides an extreme example of the willingness of some courts to issue injunctions where a defendant's loss far exceeds the plaintiffs benefit. In the Union Bag case (discussed later in Boomer, 257 N.E.2d at 872) the court assessed the plaintiff's harm at $100 per year, while compliance with the injunction caused the permanent closing of a mill at an investment loss of more than $1,000,000. 101 N.E. at 805. The New York Court of Appeals concluded, "[A]lthough the damage to the plaintiff may be slight as compared with the defendant's expense of abating the condition, that is not a good reason for refusing an injunction." Id. at 806; see also Ian Ayres & Kristin Madison, Threatening Inefficient Performance of Injunctions and Contracts, 148 U. PA. L. REV. 45 (1999).
113. The single-chooser rules can also be distributively embarrassing when there is a great disparity in the litigants' mean valuations. Such rules can force the policy makers at times to confront unpalatable divisions. For example, if a court decided that the residents in Boomer were the more efficient choosers, it would have to choose between a call rule, which might force residents to pay a large sum to stop the pollution, and a put rule, which might force the polluter to disgorge all of its expected profits from polluting. Our foregoing convexity result, however, resolves the distributive embarrassment under either the single-or dual-chooser implementations.
114. Of course, if their mean valuations diverge too much (or more specifically, if their probability distributions do not overlap), then the court cannot achieve, nor would they desire, a more nuanced allocation, even under the dual-chooser rules. In such an extreme case, the court would know for certain that one litigant's valuation exceeded the other litigant's valuation and would thus face no informational disadvantage. The court could therefore simply award the entitlement to the higher valuing litigant.
115. Michael A. Heller, The Tragedy of the Anticommons: Property in the Transition from Marx to Markets, 111 HARV. L. REV. 621 (1998).
116. See id. at 633-42.
117. The example can also be easily converted to show how a plaintiff-joint-veto rule can dominate any of the other three foundational allocations by simply reversing the identity of the plaintiff and defendant probability distributions - so that the plaintiffs value was distributed uniformly between $0 and $100, and the defendant's value between $80 and $180.
118. An analogous argument also shows why, in this example, a defendant-choice allocation dominates the defendant-presumption dual-chooser regime. Under a defendant-presumption rule, the defendant cannot prevent the plaintiff from under-taking and putting the entitlement to the defendant even when the high expected mean defendant has a seriously low actual valuation. This scenario exists in much of the lower-left quadrant. A defendant-presumption rule lowers the optimal damages below the litigants' mean valuations in order to increase the poorly informed plaintiff's incentive to allocate the entitlement to the defendant unilaterally. Rather than distort damages this way, however, we can even more efficiently give all the allocative power to the defendant through a single-chooser rule.
119. Δ < - $25, then the defendant-presumption allocation produces the highest payoffs.
120. See Avraham, supra note 22; Appendix, supra note 40.
121. See Ayres & Balkin, supra note 9.
122. 107. See id. at 727-28. Unlike traditional auctions, however, in which the proceeds of the auction go to a non-bidder, the internal auction produced by second (and higher-) order rules is one in which the proceeds from the winning bidder are paid to the losing bidder. One could imagine more explicit (external) auction implementations - in which the state initially took an entitlement (for some fixed payment to plaintiff) and then auctioned the entitlement to the highest bidder (with the state retaining auction proceeds). Such an auction would fully economize on the litigants' private information and could be implemented with much more transparent bidding strategies. This more explicit auction might prove the most efficient of all depending on the relative transaction costs. And by varying the initial payments from the government to each of the litigants, the explicit auction approach is also compatible with the type of distribution decoupling discussed above.
123. The same allocation might also be induced by: Π: - put(Low) + call(High) Δ: E + put(Low) - call(High) (3) Under this third implementation (3), the defendant has the initial entitlement and a put option with a low exercise price, while the plaintiff receives a call option with a high exercise price. The plaintiff and defendant might have to exercise their respective options simultaneously. The entitlement would end up with the defendant only if neither litigant vetoed such an allocation by exercising an option. Although the litigants might simultaneously exercise these options, we would still expect nontransparent strategies, as each party would hedge on its decision to exercise and hope that the other litigant would exercise at a more favorable price.
124. 124 N.W. 221 (Minn. 1910).
125. Ayres & Balkin, supra note 9, at 716. Jon Hanson and Matt Stowe first noticed this unusual aspect of Vincent. See Jon Hanson & Matt Stowe, Lecture Notes, Torts, Harvard Law School (Fall 1996) (on file with the Yale Law Journal). Robert Ellickson long ago also proposed a modification of nuisance rules that would amount to a common law implementation of a second-order rule. See Robert C. Ellickson, Alternatives to Zoning: Covenants, Nuisance Rules, and
126. The real difficulty facing a judge involves reduction of a litigant's valuation to a probability density function. Once a judge accomplishes this (and interactive software already exists to help quantiphobes undertake just this task through a series of yes/no questions), a piece of software can complete the fairly trivial next step of numerically calculating the optimal damages. We guess that more complicated computational problems are surmounted every time someone dials a phone number.
127. Ayres & Balkin, supra note 9, at 717, proved that the dispositive-taking principal maximized allocative efficiency when the litigants' valuations were uniformly distributed and conjectured that the principal would also hold true for more general distributions. In the Appendix, supra note 40, we prove this to be true.
128. Δ
129. Formally, the density functions would take the form: f(v) = 6v(1-v). 115. An example with the much simpler uniform distribution is derived in Ayres & Balkin, supra note 9.
130. Notice how this equilibrium comports with the dispositive takings principle. The defendant takes only when the defendant values the entitlement more than those plaintiffs who will not take it back. The class of plaintiffs who will not take hack has valuations ranging from $0 to $66.66, and the defendant will take when valuing the entitlement more than the mid-point of this range, $33.33. Similarly, the plaintiff will take back only when the plaintiff values the entitlement more than those defendants who took it in the first stage. The class of defendants from whom a plaintiff might take back has valuations ranging from $33.33 to $100, and the plaintiff will take back only when valuing the entitlement more than the midpoint of this range, $66.66.
131. Δ + 100/2, which, when solved, yield the values in the text. The nominal damages that would induce these pivot taking values equal $92.43 for the defendant's takings and $93.33 for the plaintiff taking back.
132. Δ/2, which, when solved yield the same values in the text.
133. See Ayres &Balkin, supra note 9, at 727 fig.1.
134. See id. at 729.
135. Indeed, Ayres and Balkin have shown that in a world with costless takings, successively higher-order rules can achieve successively higher expected total payoffs. See id. at 727-33. Higher-order liability rules create more refined auctions with smaller minimum bid increments, and as a theoretical matter, these rules in the limit can produce first-best efficiency.
136. Ayres and Balkin, id. at 733-36, have shown, for example, that as the transaction costs of taking or of calculating damages increase, single-price rules will tend to dominate multiple-allocative-price rules.
137. Id. at 717.
138. One still faces, however, the administration cost of determining who should be assigned the property right. Under certain circumstances, the costs of determining the high valuing litigant may exceed the costs of calculating damages. Richard R. W. Brooks, Choosing Property Rules or Liability Rules: The Burden of Determining Optimal Remedies (Aug. 2001) (unpublished working paper) (on file with authors).
139. Ayres and Talley, supra note 9, at 1065-72, stressed this point.
140. See Rose, supra note 9, at 2190-91.
141. See. e.g., Kalyan Chatterjee & William Samuelson, Bargaining Under Incomplete Information, 31 OPERATIONS RES. 835 (1983): Peter C. Cramton, Strategic Delay in Bargaining with Two-Sided Uncertainty, 59 REV. ECON. STUD. 205 (1992).
142. See. e.g., Kalyan Chatterjee & William Samuelson, Bargaining Under Incomplete Information, 31 OPERATIONS RES. 835 (1983): Peter C. Cramton, Strategic Delay in Bargaining with Two-Sided Uncertainty, 59 REV. ECON. STUD. 205 (1992).
143. See supra note 53 and accompanying text.
144. In some contexts, especially with regard to dual-chooser regimes, a potential litigant makes the first-stage choice before the court has determined damages. For example, a potential defendant may decide to encroach in anticipation of the plaintiff having the put-like choice of injunction or damages for permanent encroachment. In such circumstances, a rational encroacher would want to assess what damages the court will likely set.
145. See Ayres, supra note 9, at 794.
146. 362 N.E.2d 968 (N.Y. 1977); see also cases cited supra note 27.
147. See Richard L. Revesz, Federalism and Intersuite Environmental Externalities, 144 U. PA. L. REV. 2341, 2342-44 (1996).
148. Krier & Schwab, supra note 7, at 471-72.
149. In addition, Residents often will have higher levels of risk aversion than the Polluter, who may in turn have greater opportunities to diversify loss, and hence, Residents will, other things being equal, tend to make better choosers.
150. 257 N.E.2d 870 (N.Y. 1970).
151. See Ayres & Talley, supra note 9, at 1086.
152. Heller, supra note 100.
153. See John J. Donohue, III, Diverting the Coasean River: Incentive Schemes to Reduce Unemployment Spells, 99 YALE L.J. 549, 550 (1989); Stewart Schwab, A Coasean Experiment on Contract Presumptions, 17 J. LEGALSTUD. 237, 242-43 (1988).
154. See John J. Donohue, III, Diverting the Coasean River: Incentive Schemes to Reduce Unemployment Spells, 99 YALE L.J. 549, 550 (1989); Stewart Schwab, A Coasean Experiment on Contract Presumptions, 17 J. LEGALSTUD. 237, 242-43 (1988).
155. See A. MITCHELL POLINSKY, AN INTRODUCTION TO LAW AND ECONOMICS 7-10, 119-27 (2nd ed. 1989); Siewart J. Schwab, Coase Defends Coase; Why Lawyers Listen and Economists Do Not, 87 MICH. L. REV. 1171, 1178-83 (1989) (book review).
156. See A. MITCHELL POLINSKY, AN INTRODUCTION TO LAW AND ECONOMICS 7-10, 119-27 (2nd ed. 1989); Siewart J. Schwab, Coase Defends Coase; Why Lawyers Listen and Economists Do Not, 87 MICH. L. REV. 1171, 1178-83 (1989) (book review).
157. Mark Kelman, Consumption Theory, Production Theory and Ideology in the Coase Theorem, 52 S. CAL. L. REV. 669, 673 (1979); Duncan Kennedy, Cost-Benefit Analysis of Entitlement Problems: A Critique, 33 STAN. L. REV. 387, 401 (1981); Russell Korobkin, Note, Policymaking and the Offer/Asking Price Gap: Toward a Theory of Efficient Entitlement Allocation, 46 STAN. L. REV. 663 (1994).
158. Mark Kelman, Consumption Theory, Production Theory and Ideology in the Coase Theorem, 52 S. CAL. L. REV. 669, 673 (1979); Duncan Kennedy, Cost-Benefit Analysis of Entitlement Problems: A Critique, 33 STAN. L. REV. 387, 401 (1981); Russell Korobkin, Note, Policymaking and the Offer/Asking Price Gap: Toward a Theory of Efficient Entitlement Allocation, 46 STAN. L. REV. 663 (1994).
159. Mark Kelman, Consumption Theory, Production Theory and Ideology in the Coase Theorem, 52 S. CAL. L. REV. 669, 673 (1979); Duncan Kennedy, Cost-Benefit Analysis of Entitlement Problems: A Critique, 33 STAN. L. REV. 387, 401 (1981); Russell Korobkin, Note, Policymaking and the Offer/Asking Price Gap: Toward a Theory of Efficient Entitlement Allocation, 46 STAN. L. REV. 663 (1994).
160. Levmore, supra note 9, at 2166.
161. See Herbert Hovenkamp, Legal Policy and the Endowment Effect, 20 J. LEGAL STUD. 225, 232-34, 245-47 (1991) (claiming that willingness to accept should always be used rather than willingness to pay). Russell Korobkin, however, has suggested reasons why allocation of entitlements on the basis of willingness to accept is inappropriate when independent social norms oppose sales of certain types of entitlements: Narrowly stated, our society teaches us that we should not sell some things, although buying them is socially acceptable. Although an individual might, in a cultural vacuum, prefer a specific quantity of money to a certain entitlement, he might feel that selling the entitlement is improper and therefore, his WTA will exceed his WTP. This explanation has been called the "dignity hypothesis." Korobkin, supra note 140, at 691-92.
162. Daniel Kahneman et al., Experimental Tests of the Endowment Effect and the Coase Theorem, 98 J. POL. ECON. 1325 (1990).
163. Jeffrey J. Rachlinski & Forest Jourden, Remedies and the Psychology of Ownership, 51 VAND. L. REV. 1541, 1545 (1998) (arguing that "the endowment effect might depend on whether the law protects an interest with a property rule or a liability rule"). This possibility was first suggested in Ayres & Talley, supra note 9, at 1102.
164. Russell Korobkin, however, has suggested to us that the put option may commodify the entitlement in the owner's mind in ways that reduce the endowment effect. Imagine that after a pure-bred dog has puppies, a mother tells her daughter she can keep the puppies or, after they are weaned, can sell them for $50 to a neighbor who has made a firm offer. The daughter's knowledge that she has a put option might stop her from bonding as closely with the puppies during the weaning period as she would have otherwise and hence mitigate the endowment effect.
165. See Russell Korobkin, The Status Quo Bias and Contract Default Rules, 83 CORNELL L. REV. 608 (1998).
166. For example, in many nuisance contexts it is plausible to assume that a Polluter's value from polluting will be independent of a Resident's value of nonpollution.
167. Kaplow & Shavell, supra note 15, at 759.
168. Id. at 759-60 ("First, suppose that things have a significant common value, that is, a component of value that is the same for both the owner and any laker. . . . Second, assume that things also have idiosyncratic value to individuals. Idiosyncratic value derives from characteristics of a thing that different individuals evaluate differently, such as the design of a home.").
169. Id., at 760.
170. See Ian Ayres & Paul M. Goldbart, A Critique of "Tangibility" as the Basis for Property Rules (2001) (unpublished manuscript) (on file with authors).
171. In the foregoing example, Rule 1 produces an expected payoff of $100, while the optimal plaintiff-presumption dual-chooser rule produces an expected payoff of $101.39.
172. Farnsworth, supra note 29.
173. See Jennifer Gerarda Brown & Ian Ayres, Economic Rationales for Mediation, 80 VA. L. REV. 323, 331 & nn.26 & 27 (1994).
174. Kaplow & Shavell, supra note 15, passim. 156. Ayres & Talley, supra note 9, at 1104.
175. Under a put implementation of a defendant-choice rule, the plaintiffs would offer to pay the defendants not to exercise their put only when the plaintiffs have an actual valuation lower than the court's estimate of their mean valuation, and the plaintiffs would offer to pay the defendants for the underlying entitlement only when the plaintiffs have an actual valuation higher than the court's estimate of it.
176. The defendant could also credibly signal its high value by exercising its first-stage call option. But the information-forcing stressed in the text allows the defendant to signal its high valuation even before it is called upon to exercise its first-stage option.
177. See Ayres & Talley, supra note 9; Epstein, supra note 9; Rose, supra note 9.
178. Ayres & Talley, supra note 9, at 1743.
179. Even under the call implementation, it is not clear why this argument makes sense. If Krier at the time of investment does not yet know his true valuation, then promising him his mean valuation should not deter his investment. Indeed, if he is risk averse it may decrease the variance in his payoffs and make him more willing to invest. If, however, Krier at the time of investing knows his future valuation, then promising him his mean valuation, should Schwab take the entitlement, may deter him from some valuable types of investment when his actual value turns out to be higher than the court's perception of his mean valuation.
180. Conversely, choosers may allocate the entitlement to the nonchoosers, not because they have low idiosyncratic valuations but because their common-value element takes on an unexpectedly low value that falls short of the court's allocative price.
181. Although, as we note above, supra text accompanying note 151, Kaplow and Shavell fail to compare the property rule to the most efficient single-chooser rule because their example uses the less efficient chooser and nonoptimal damages.
182. Ayres & Talley, supra note 9, at 214; Epstein, supra note 9, at 2195; Rose, supra note 9, at 2180.
183. To begin, the absence of contract law from Calabresi and Melamed's view of the cathedral is striking. The subject might have been omitted because contracts didn't fit their theory well. Calabresi and Melamed have been understood by subsequent scholars to have argued that liability rules tend to dominate when transaction costs are high but that property rules dominate when transaction costs are low. Contractual entitlements don't fit because they are protected by liability rules even though transaction costs were sufficiently low for the parties to enter into an initial contract.
184. Spur Indus., Inc. v. Del E. Webb Dev. Co., 494 P.2d 700, 708 (Ariz. 1972).
185. Ayres & Balkin, supra note 9, at 746.
186. Courts should limit the buyer's ability to augment the seller's potential damages to circumstances in which performance can feasibly occur. Otherwise, buyers might make an inflated offer for performance (that is, an offer that exceeds their private valuation of performance) if they know that changed circumstances have rendered the seller's performance impossible. See id, at 747 n.137.
187. Buyers deciding how much extra to offer for performance would have a powerful incentive not to offer too much. If the offer grows too generous, the seller would simply accept it and perform.
188. See Gianna Julian-Arnold, International Compulsory Licensing: The Rationales and the Reality, 33 IDEA 349 (1987) (noting that blocking patents are one of the three most common conditions for compulsory licensing abroad). Countries that have compulsory licenses for blocking patents include Australia, China, France, Japan, the Netherlands, New Zealand and Switzerland. See ROBERT MERGES, INTELLECTUAL PROPERTY RIGHTS AND BARGAINING BREAKDOWN: THE CASE OF IMPROVEMENT INVENTIONS AND BLOCKING PATENTS 30-31 (1994). U.S. patent law also mandates compulsory licenses with regard to nuclear power and environmental engineering technologies. See Ayres & Talley, supra note 9, at 1093.
189. See Gianna Julian-Arnold, International Compulsory Licensing: The Rationales and the Reality, 33 IDEA 349 (1987) (noting that blocking patents are one of the three most common conditions for compulsory licensing abroad). Countries that have compulsory licenses for blocking patents include Australia, China, France, Japan, the Netherlands, New Zealand and Switzerland. See ROBERT MERGES, INTELLECTUAL PROPERTY RIGHTS AND BARGAINING BREAKDOWN: THE CASE OF IMPROVEMENT INVENTIONS AND BLOCKING PATENTS 30-31 (1994). U.S. patent law also mandates compulsory licenses with regard to nuclear power and environmental engineering technologies. See Ayres & Talley, supra note 9, at 1093.