Columbia Law School Scholarship Archive Faculty Scholarship Faculty Publications 1990 The Strategic Structure of Offer and Acceptance: Game Theory and the Law of Contract Formation Avery W. Katz Columbia Law School, [email protected] Follow this and additional works at: https://scholarship.law.columbia.edu/faculty_scholarship Part of the Contracts Commons, and the Law and Economics Commons Recommended Citation Avery W. Katz, The Strategic Structure of Offer and Acceptance: Game Theory and the Law of Contract Formation, 89 MICH. L. REV. 215 (1990). Available at: https://scholarship.law.columbia.edu/faculty_scholarship/611 This Article is brought to you for free and open access by the Faculty Publications at Scholarship Archive. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of Scholarship Archive. For more information, please contact [email protected]. THE STRATEGIC STRUCTURE OF OFFER AND ACCEPTANCE: GAME THEORY AND THE LAW OF CONTRACT FORMATION Avery Katz* TABLE OF CONTENTS I. INTRODUCTION: THE COSTS OF A CONVENTIONAL APPROACH ............................................. 216 II. THE BARGAINING PROBLEM IN LAW AND ECONOMICS . 225 A. The Relation Between Substantive Legal Rules and Bargaining........................................ 227 B. The Effect of Contract Formation Rules on Bargaining ........................................ 230 III. A SKETCHY SURVEY OF THE ECONOMICS OF BARGAINING .......................................... 232 IV. APPLICATION OF THE GAME-THEORETIC APPROACH: SOME CAVEATS ........................................ 243 A. Selecting the Best Formal Model ................... 244 B. Limitations of the Game-Theoretic Approach ........ 247 V. A FULL INFORMATION MODEL: ACCEPTANCE BY SILENCE ............................................... 249 A. The DoctrinalBackground ......................... 250 B. The Formal Model ................................. 256 C. A Variation on the Model. Subjective Intention To Accept ............................................ 265 D. Comments on the Model ........................... 269 VI. AN IMPERFECT INFORMATION MODEL: STANDARDIZED FORM CONTRACTS ..................................... 272 A. The DoctrinalBackground ......................... 274 B. Baird and Weisberg's Defense of the Duty To Read . 277 * Assistant Professor of Law and of Economics, University of Michigan. B.A. 1980, Michi- gan; A.M. 1983, J.D. 1985, Ph.D. 1986, Harvard. - Ed. I am grateful to Ian Ayres, Mark Bagnoli, Richard Craswell, Sharon Feldman, Richard Lempert, Richard Pildes, Roberta Ro- mano, Joel Seligman, Steven Shavell, Robert Thomas, James J. White, and seminar participants at Michigan, Georgetown, Chicago, Harvard, and Yale Law Schools for helpful comments, and to the Cook Fund of the University of Michigan Law School and the Center for Studies in Law, Economics, and Public Policy at Yale Law School for financial support. Michigan Law Review [V/ol. 89:215 C. A FormalModel of the Duty To Read .............. 282 D. Comments on the Model ........................... 290 CONCLUSION ................................................. 293 I. INTRODUCTION: THE COSTS OF A CONVENTIONAL APPROACH ,The purpose of this article is to promote a particular research pro- gram; namely, the use of game theory to analyze the law of contract formation. Although I will often simply speak of offer and acceptance in my discussion, I mean to refer to a broader set of issues than are commonly denoted by this doctrinal label. My program transcends the narrow issue of whether particular communications technically should be classified as offers and acceptances, and includes questions often analyzed under the rubrics of implication and interpretation. At its broadest, my argument addresses all legal rules that answer two types of questions: First, which objectively verifiable actions or subjec- tively experienced intentions suffice to conclude a bargain and form a contractual obligation? Second, how do these actions and intentions affect the substantive content of any contract formed? The legal doctrines governing these questions present some of the more subtle and technical problems in all of the law. Their metaphysi- cal controversies and mechanical intricacies have puzzled countless lawyers and judges and have consigned generations of law students to torment at the hands of their professors. Yet the law of offer and ac- ceptance has generated relatively little interest in the literature that addresses contract law from a policy perspective. Instead, commenta- tors concerned with public policy have focused largely on the conse- quences of contracts after formation. In particular, there has been little formal analysis of the rules of contract formation and interpretation in the law and economics litera- ture, except in a narrow, limited sense.' Legal scholars influenced by economics have generated a substantial literature on contract reme- 1. There are a few recent and laudable exceptions, most prominently Ayres & Gertner, Fill- ing Gaps in Incomplete Contracts" An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989). An alternative approach is provided by Coleman, Heckathorm & Maser, A Bargaining Theory Approach to Default Provisions and DisclosureRules in Contract Law, 12 HARv. J.L. & PUB. POLY. 639 (1989), who examine the law of bargaining from the perspective of cooperative game theory. As I explain in Part III, I consider the noncooperative game-theoretic approach of the former authors more useful, since the cooperative approach, while illuminating, is not well grounded in the theory of individual rational choice. November 1990] Game Theory and Contract Formation dies,2 on excuse for mistake, impossibility, and frustration of purpose,3 and on private enforcement of contracts,4 among other topics. But these scholars nonetheless have been primarily concerned with pre- dicting the consequences of substantive contract terms of various sorts, and with identifying the optimal content of these terms. These writers, for the most part, have addressed formation and in- terpretation only in arguing that the particular substantive terms that they have identified as optimal should as a general practice be implied, either in fact or in law, by courts enforcing contracts. This type of interpretive claim is widespread in the policy literature. A common version of it holds that because it is too costly for contracting parties explicitly to provide for every possible aspect of their bargain, courts can promote efficiency, fairness, or other socially desirable objectives by implying the optimal terms when the parties fail expressly to pro- vide otherwise. A variation on this theme, while recognizing that opti- mal substantive terms may vary depending on the contracting parties' individual circumstances, asserts that a default rule that implies terms optimal for typically situated parties will best promote the desired so- cial goal. Additionally, some claim an optimally chosen default rule will minimize the total costs incurred by those who wish to negotiate around the implied term. While these sorts of arguments have intuitive appeal in many set- tings, the premises necessary for their validity remain unexamined. In order to assess how parties will react to rules of presumptive interpre- tation, it is necessary to consider the parties' individual incentives to engage in negotiation under various possible interpretative regimes. And those who argue in favor of default rules and presumptive terms have rarely investigated the parties' incentives to bargain with any- where near the detail or rigor that they have explored the parties' wishes regarding the particular substantive term under consideration. 2. The literature is too extensive to cite here in full. Prominent articles include Cooter & Eisenberg, Damagesfor Breach of Contract 73 CALIF. L. REv. 1434 (1985); Craswell, Precon- tractualInvestigation as an Optimal PrecautionProblem, 17 J. LEGAL STUD. 401 (1988); Polin- sky, Risk SharingThrough Breach of ContractRemedies; 12 J. LEGAL STUD. 427 (1983); Shavell, The Design of Contractsand Remedies for Breach, 99 Q.J. EcoN. 121 (1984); Shavel, Damage Measures for Breach of Contract, 11 BELL J. ECON. 466 (1980); and Ulen, The Efficiency of Specific Performance: Toward a Unified Theory of Contract Remedies, 83 MICH. L. REv. 341 (1984). 3. See, e-g., Posner & Rosenfield, Impossibility and Related Doctrines in Contract Law: An Economic Analysis; 6 3. LEGAL STUD. 83 (1977); White, ContractBreach and ContractDischarge Due to Impossibility: A Unified Theory, 17 J. LEGAL STUD. 353 (1988). 4. See, eg., Klein & Leffler, The Role of Market Forcesin Assuring ContractualPerformance, 89 J. POL. ECON. 615 (1981); Kornhauser, Reliance, Reputation, and Breach of Contract,26 J.L. & EcoN. 691 (1983); Telser, A Theory of Self-Enforcing Agreements, 53 J. Bus. 27 (1980); Wil- liamson, Credible Commitments: Using Hostages to Support Exchange, 73 AM. ECON. REv. 519 (1983). Michigan Law Review [Vol. 89:215 Accordingly, the mechanical rules of contract formation so be- loved to hornbook authors and bar examiners, and the related body of legal doctrine that helps imply the content of the contract from the history of the bargaining, largely have escaped attention from those legal scholars influenced by economics.5 The preponderance of the literature treats such rules as largely conventional, and accordingly irrelevant for purposes of policy analysis. Instead, the prevailing if implicit paradigm is well captured