Credible Commitments: Private Ordering

As indicated earlier, the legal centralism tradition maintains that the courts are well suited for administering justice whenever contract disputes arise. If few cases are brought to the courts for disposition, that is only because contracts are carefully drawn and/or because the law of contract is fully nuanced and the relevant facts are easy to display. Litigated disputes rarely arise, because the parties can anticipate their disposition and will quickly effect settlement themselves. The exceptions—that is, the cases that appear in court—merely prove the rule that court ordering is efficacious.

The private ordering approach disputes that view. It maintains instead that contracts should be regarded as framework and as a basis for ultimate appeal (Llewellyn, 1931). All contracts, but especially long-term contracts, are incomplete and imperfect documents. Consider the following “general clause” that appears in the thirty-two-year coal supply agreement between the Nevada Power Company and the Northwest Trading Company:

It is the intent of the Parties hereto that this Agreement, as a whole and in all of its parts, shall be equitable to both Parties throughout its term. The Parties recognize that omissions or defects in the Agreement beyond control of the Parties or not apparent at the time of its execution may create inequities or hardships during the term of the Agreement, and further, that supervening conditions, circumstances or events beyond the reasonable and practicable control of the Parties, may from time to time give rise to inequities which impose economic or other hardships upon one or both of the Parties. In the event an inequitable condition occurs which adversely affects one Party, it shall be the joint and equal responsibility of both Parties to act promptly and in good faith to determine the action required to cure or adjust for the inequity and effectively to implement such action. Upon written claim of inequity served by one Party upon the other, the Parties shall act jointly to reach an agreement concerning the claimed inequity within sixty (60) days of the date of such written claim. An adjusted base coal price that differs from market price by more than ten percent (10%) shall constitute a hardship. The Party claiming inequity shall include in its claim such information and data as may be reasonably necessary to substantiate the claim and shall freely and without delay furnish such other information and data as the other Party reasonably may deem relevant and necessary. If the Parties cannot reach agreement within sixty (60) days the matter shall be submitted to arbitration. |1980, pp. 10-11]

Unlike a comprehensive contract, this contract contemplates omissions, drafting defects, and unanticipated contingencies. Contrary to legal centralism, bilateral and trilateral (arbitration) efforts will be used to settle disputes rather than have immediate recourse to court ordering.

Hobbes’s interesting discussion of oaths and promises in The Leviathan is pertinent:

The force of words, being, as 1 have formerly noted, too weak to hold men to the performance of their covenants; there are in man’s nature, but two imaginable helps to strengthen it. And those are either fear of the consequence of breaking their word; or a glory, or pride in appearing not to break it. The latter is a generosity too rarely found to be presumed on, especially in the pursuers of wealth, command, or sensual pleasure; which arc the greatest part of mankind … So that before the time of civil society… there is nothing can strengthen a covenant of peace agreed on, against the temptations of avarice, ambition, lust, or other strong desire, but the fear that invisible power, which they every one worship as God; as fear as a revenger of their perfidy. IHobbcs 1928, pp. 92-93]

Accordingly, Hobbes concluded that “there must be some coercive power, to compel men equally to perform their covenants” (1928, p. 94). That legal centralism solution has had widespread appeal to many lawyers and social scientists. Jerold Auerbach s recent examination of the incapacity of private parties to order their affairs effectively is illustrative.

Auerbach observes that the “success of non-legal dispute settlement has always depended on a coherent community vision” (1983, p. 4). Although religious communities provided the necessary coherence within early colonial settlements in America, recourse to litigation in the courts became common and permissible as religious intensity waned (p. 5). The fundamental dilemma is that the benefits of individualism to which Americans aspire are realized only by relying extensively on the “legal system” (pp. 10, 146).

Auerbach nevertheless acknowledges that “business interests” may be an exception. The communitarian’value that he ascribes to business is “a community of profit Selfish and secular to the core, they nevertheless have emerged among the most persistent American defenders of alternative dispute settlement” (1983, p. 6). He thus records the paradox that “the pursuit of self- interest and profit generated its own communitarian values, which commercial arbitration expressed. The competitive individualism of the marketplace was checked by the need for continuing harmonious relations among men who did business with each other” (p. 44).

The paradox to which he refers derives from the view that private ordering is possible only if supported by communitarian values, which values are presumed to be alien to a business relationship. Assuming that the term “communitarian” is given its ordinary signification, such baggage is both unneeded and unhelpful. The study of economic organization is better served, I submit, by focusing on the purposes served. As Philip Wicksteed put it

We enter into business relations with others, not because our purposes are selfish, but because those with whom we deal are relatively indifferent to them… There is surely nothing degrading or revolting to our higher sense in this fact of our mutually furthering each others purposes because we are interested in our own …. [The nexus of exchange] indefinitely expands our freedom of combination and movement; for it enables us to form one set of groups linked by cohesion of [diverse] faculties and resources, and another set of groups linked by community of purpose, without having to find the “double coincidence” which would otherwise be necessary. [Robbins, 1933, pp. 179-80]

Extensive recourse to private ordering is hardly a paradox if the limits of contract and of the courts are recognized from the outset and if the issues of organization are posed comparatively. Inasmuch, moreover, as the benefits of “continuing harmonious relations” to which Auerbach refers are not unique to business but apply to organizations of all kinds, while the limits of courts for dealing with complex problems are everywhere severe, greater attention to the ways by which conflict is mitigated ex ante and to the range of formal and informal devices by which disputes are settled ex post is needed. The possibility that “credible commitments” play a larger role in the making and execution of contracts than has hitherto been recognized is among the matters that warrant study.

Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.

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