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The economic impact of a shift from hard to fuzzy contracts

The economic impact of a shift from hard to fuzzy contracts Purpose – This paper aims to explain the economic impact of the change in the degree of contract enforcement in the USA since August 2008. This change, from solid enforcement (hard contracts), to uncertain enforcement (fuzzy contracts), is a result of political expediency during an economic crisis. The purpose of the paper is to point out that political decisions are not made in an economic vacuum, and that there is an economic impact to the move away from hard contracts. Design/methodology/approach – The paper uses a time value of money, net present value approach with specific emphasis on the investor's adjustment to the required rate of return in the face of uncertain contract enforcement. Both closed and open economic systems are addressed. Findings – The paper finds that in the shift to a fuzzy contract environment, investors will increase the required rate of return on future investment contracts, thereby lowering the value of those assets. Both individually, and in the aggregate, asset values will fall. Research limitations/implications – The paper makes no attempt to evaluate reasons for or against the institutional changes that produced the move to fuzzy contracts. The paper examines only the resulting impact of the change on asset valuations. Practical implications – Reducing the certainty of contract enforcement reduces asset valuations and investment. Originality/value – This paper fulfills a need to be cognizant of the fact that actions of politicians can have unintended economic consequences, using the specific example of the shift in contract enforcement in the USA since August 2008. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Financial Economic Policy Emerald Publishing

The economic impact of a shift from hard to fuzzy contracts

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Publisher
Emerald Publishing
Copyright
Copyright © 2010 Emerald Group Publishing Limited. All rights reserved.
ISSN
1757-6385
DOI
10.1108/17576381011055352
Publisher site
See Article on Publisher Site

Abstract

Purpose – This paper aims to explain the economic impact of the change in the degree of contract enforcement in the USA since August 2008. This change, from solid enforcement (hard contracts), to uncertain enforcement (fuzzy contracts), is a result of political expediency during an economic crisis. The purpose of the paper is to point out that political decisions are not made in an economic vacuum, and that there is an economic impact to the move away from hard contracts. Design/methodology/approach – The paper uses a time value of money, net present value approach with specific emphasis on the investor's adjustment to the required rate of return in the face of uncertain contract enforcement. Both closed and open economic systems are addressed. Findings – The paper finds that in the shift to a fuzzy contract environment, investors will increase the required rate of return on future investment contracts, thereby lowering the value of those assets. Both individually, and in the aggregate, asset values will fall. Research limitations/implications – The paper makes no attempt to evaluate reasons for or against the institutional changes that produced the move to fuzzy contracts. The paper examines only the resulting impact of the change on asset valuations. Practical implications – Reducing the certainty of contract enforcement reduces asset valuations and investment. Originality/value – This paper fulfills a need to be cognizant of the fact that actions of politicians can have unintended economic consequences, using the specific example of the shift in contract enforcement in the USA since August 2008.

Journal

Journal of Financial Economic PolicyEmerald Publishing

Published: Apr 20, 2010

Keywords: Economic conditions; Politics; Government policy; Contract law; United States of America

References