ABSTRACT
In contracts, the choice between vague standards and precise rules is central to both theory and practice. According to traditional contract theory, parties make this choice by balancing ‘front-end’ transaction costs against ‘back-end’ enforcement costs, apparently through a joint cost-benefit analysis. Despite longstanding and undisputed acceptance in academia, this conception of contract design is virtually unknown among practicing lawyers. Bridging that gap, this Article is the first to analyze this paradigm critically, improve it significantly, and propose practical ways to implement it.
Though intuitive and insightful, the prevailing theory ignores typical negotiation dynamics, impeding its real-world applicability. Portraying transactional practice more accurately, this Article refines this model to reflect that parties strategically withhold information and prioritize their individual costs, not their collective costs. Even with these improvements, however, any comprehensive cost-benefit analysis of contract terms is impossible and wasteful under human cognitive constraints, so just attempting it is irrational.
Toward a truly rational approach to contract design, deliberate heuristics – planned decision-making strategies that simplify complex judgments – promise greater efficacy in the profoundly uncertain environment of business transactions. Applying recent developments in behavioral science, this Article formulates and demonstrates a decision tree for choosing between vague and precise provisions. Compared with the cost-benefit analysis suggested by legal scholarship, this strategy identifies efficient language more consistently and quickly, finally enabling drafters to implement contract theory’s normative insights in practice. Based on this effective approach, future heuristics could also facilitate rational judgments in other central aspects of contract design.
Thomas, Naveen, Rational Contract Design (February 1, 2022). Alabama Law Review, forthcoming.
First posted 2022-03-09 10:00:39
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