Enforcement by Hearing: How the Civil Law Sets Incentives
This paper investigates the manner in which the civil law sets incentives, given that courts do not directly observe the activities that the law would hope to control. What distinguishes the civil law problem from other hidden action problems is that the principle (the court) conditions its rewards and punishments on signals (evidence presented) of the agents' choosing. Thus unlike the output signal used by the employer in the classic moral hazard problem, the signal here is itself strategic. The paper proposes a model that casts the civil law's problem as a combination of moral hazard in the underlying activity and adverse selection in a second-stage signaling game (the "hearing"), where "types" in the latter are determined by actions in the former. Types correspond to the difficulty or costs of presenting various pieces of evidence. By carefully setting its liability per evidence schedule, the court may separate types in the second stage hearing by hearing payoffs they receive. Since the type is contingent on initial action, an appropriate separation at the hearing will create the desired incentives in the underlying activity. After analyzing the basic single agent model with mandatory post-action hearings, the paper considers multiple parties and voluntary filing of suits.
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