A New Angle on Rules versus Standards

Abstract

The debate over standards versus rules has traditionally been framed by economists as a trade-off between the certainty and lower administrative costs of firm legal rules and the greater flexibility to adjust decisions according to the particular context of the case that comes from using looser legal standards. In this paper we argue that even if judges have no ability to directly assess how the context of the case should affect their decisions, using flexible standards creates a sorting effect that leads the court to favor the decision that is ex-post efficient. When judges are not bound by rigid rules, their decision is more likely to be sensitive to the quality of legal representation. When we are concerned primarily with ex-post effects of the decision, and when the decision only affects the parties to the law suit, the party that desires the efficient decision has the most to gain, and would be expected to exert the most effort, and would thus be more likely to prevail under a standards based system. We would also expect that more resources are spent on litigation under a standards and this can easily outweigh the increased likelihood of an efficient decision. However, we show that bargaining in the shadow of standards can preserve the sorting benefit of standards while ameliorating the increase in legal costs. We argue that in these circumstances, the sorting effect can be a strong argument in favor of a standards based system.