Verifiability and Contract Enforcement : A Model with Judicial Moral Hazard

We model the litigation of a contract containing a variable not observable by courts, hence non verifiable, unless the rational and self-interested judge exerts effort. He values the correct ruling but dislikes effort. Judicial effort is discretionary. We show that effort cost is inconsequential, - "always breach" is equilibrium for any effort cost. But there exists another equilibrium where a small breach rate is achieved even with significant effort costs. Maximal remedies for breach are not optimal. Because effort is discretionary, low effort cost increases breach. Pre-trial negotiations can have a substantial negative impact on verifiability under arbitrarily small deviations from full rationality