Saturday, January 12, 2008

Prenuptial Agreements: Why Divorces Cost More Without Them Than With Them

I practice family law and am not an economist. Which may be when I found Pre- and Post-Nuptial Agreements: Contract Incompleteness as a Strategic Device (pdf format), I could not resist looking. Still, it is 33 page and I have work still to do. I will put off reading the remaining 32 pages till later. However, I will leave you with the abstract and I think it is obvious why this has the potential for being very interesting:

In recent years family law has changed in many countries making enforceable premarital contracts which settle how partners have to divide their marital assets in case of divorce. Nevertheless, many couples do still not write premarital contracts and end up their relation in costly litigation. Traditionally, the evidence that many contracts are silent in some states of the world, is explained by the presence of some costs in writing complete contracts. We argue that, at least in the case we deal with, this explanation is far from being satisfactory. Incomplete contracts may be more costly that complete ones, since their gaps must be filled later, and completing a contract turns out to be costly. We model an economy where writing complete contracts is almost costless, both ex-ante and ex-post, and where any relevant aspect of the interaction between partners may be observed and verified. Therefore contract incompleteness must be a form of optimal contracting. In our model, incompleteness stems from the existence of private information. In particular it is both a signalling and screening device in order to credibly communicate to be a reliable partner and to select partners with the same quality. The lack of premarital agreements basically keeps divorce costly. This threat is credible since contract incompleteness opens the door to moral hazard problems in the relationship, inducing agents to choose costly ex-post verification, which could be avoided by specifying in a premarital contract a precise entitlement of the marital assets in case of divorce. We investigate under which condition contract incompleteness is an optimal form of contracting, arguing that it depends on the institutional design. Finally, we show when the institutional framework which gives rise to contract incompleteness is efficient.

No comments: