The Choice between Property Rules and Liability Rules Revisited : Critical Observations from Behavioral Studies

One of the most fundamental issues every legal system must address is the form of protection that should be given to legal entitlements. Calabresi & Melamed offered a simple, elegant criterion for choosing between property rules and liability rules, namely transaction costs. Property rules should be used when transaction costs are low and the parties can bargain with one another. Liability rules are best applied when transaction costs are high and bargaining is impossible or difficult. Recently, however, Ayres & Talley, Kaplow & Shavell, and others have questioned this conventional wisdom. In particular, they claim that liability rules may be superior to property rules even when transaction costs are low. The Article criticizes the new arguments in favor of liability rules, and vindicates the superiority of property rules in low-transaction-cost situations. It draws on insights from behavioral and psychological studies of bargaining behavior to support the use of property rules when bargaining is possible. In doing so, this Article differs from previous critiques of liability rules. In particular, analysis of Ultimatum Game bargaining experiments reveals that negotiation under property rules may be much more successful than scholars tend to assume. Property rules encourage parties to fairly share the gains from the trade and reduce the magnitude of entitlement owners' endowment effect. In contrast, investigation of Dictator Game experiments shows that bargaining in the shadow of liability rules is significantly more problematic than most writers acknowledge. Liability rules induce egoistic behavior, intensify owners' endowment effect and discourage agreement between the parties. Consequently, the negotiation process is prone to end in failure. The subsequent need to resort to coercion powers becomes a self-fulfilling prophecy with negative results in terms of both efficiency and private autonomy. The Article explores the various normative implications of this argument