It is a common argument in law and economics that divided ownership can create or exacerbate strategic behavior. For instance, when several persons own the land designated for a proposed stadium, individual sellers may "hold out" for a disproportionate share of the gains from trade. Alternatively, when building a public library would benefit multiple residents, individual buyers may "free ride" on the willingness of others to pay for its construction. Such transaction costs of collective action fall under a variety of analytic rubrics, including the "tragedy of the commons" and the theory of "public goods." Nonetheless, each example of market failure shares a common attribute: The division of a single legal entitlement, or of rivalrous entitlements, among joint sellers or joint buyers may prevent socially efficient transactions, particularly when the parties possess private information about their preferences.
This Article explores a different way of dividing an entitlement. Rather than analyzing divisions among buyers or among sellers, we consider the effects of splitting an entitlement between the two groups. Our core insight is Solomonic in character: Dividing a legal entitlement between rivalrous users can facilitate efficient trade. More specifically, we show that when two parties have private information about how much they value an entitlement, endowing each party with a partial claim to the entitlement can reduce the incentive to behave strategically during bargaining, thereby enhancing economic efficiency.
Private information is a particularly pernicious form of transaction cost, especially in legal contexts where, for procedural or other reasons, parties must negotiate within "thin" markets. In such contexts, self-interested bargainers have a strong incentive to misrepresent their private valuations so as to capture a larger share of the bargaining "pie." These incentives often lead to predictable opportunistic strategies: Sellers tend to overstate the value they place on the bargained-for item, while buyers tend to understate their desire to purchase it. As a result of such strategic behavior, the parties may fail to detect and exploit a mutually beneficial trade, and even when they can it is usually after considerable and costly delay.
In this Article, we argue that divided entitlements can facilitate trade by inducing claim holders to reveal more information than they would under an undivided entitlement regime. Owners of divided, or "Solomonic," entitlements must bargain more forthrightly than owners of undivided entitlements, because the entitlement division obscures the titular boundary between "buyer" and "seller." More precisely, endowing each bargainer with a share of the underlying entitlement creates the possibility of two different types of Coasean trade: A bargainer might buy the other party's claim, or, alternatively, she might sell her own. During negotiation, each party is likely to be uncertain about whether she will ultimately emerge as a seller or a buyer. This strategic "identity crisis" can strongly mitigate each party's incentive to misrepresent her respective valuation; each party must balance countervailing interests in shading up her valuation, as one would qua seller, and shading down her valuation, as one would qua buyer. This form of rational ambivalence, we argue, can lead the bargainers to represent their valuations more truthfully.
Law | Law and Economics | Property Law and Real Estate
Ian Ayres & Eric Talley,
Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade,
Yale L. J.
Available at: https://scholarship.law.columbia.edu/faculty_scholarship/225