Shrink-Wraps: Who Should Bear the Cost of Communicating Mass-Market Contract Terms?

Abstract

The paper examines the equilibrium quality of mass market contract terms, such as those in end user license agreements, when consumers can read and search for a better set of terms. Firms compete over price and quality of the terms. They can also choose to disclose (speak) the terms to consumers at cost. While all consumers must incur positive search (reading) cost to understand the terms, not everyone cares about the terms equally and they can also buy without reading. The paper examines two legal regimes: one that imposes a duty to read on the consumers and the other that imposes a duty to speak (disclose) on the firms. While neither regime strictly dominates the other in terms of social welfare, the paper shows that (1) as the reading or speaking cost converges to zero, the social welfare continuously converges to the first best; (2) consumers will have different preferences over duty-to-speak and dutyto-read regimes; and (3) the quality of the terms of non-disclosing firms may be higher. The results are consistent with the current chasm among scholars and courts over mandatory disclosure policy and also with the recent empirical findings. * Preliminary and Incomplete. Please do not cite or quote without permission. Acknowledgements to be added. Comments are welcome to yc2271@columbia.edu or ahc4p@virginia.edu.

Protecting buyers from fine print

“…This is not true in Che and Choi because they assume that sellers must o¤er a single contract to buyers with heterogeneous valuations. This paper, like Katz (1990), Che andChoi (2009) andRasmusen (2001), is related to the literature on auditing/inspection games, as surveyed by Avenhaus et al (2002) and Avenhaus and Canty (2009). Our results on unregulated trade reproduce a fundamental property of inspection games with a …nite number of feasible terms: favorable contracts can only be o¤ered in equilibrium if buyers and seller(s) monitor each other by mixing: sometimes o¤ering unfavorable contracts and sometimes reading.…”

“…In Che and Choi (2009), competitive sellers can incur a cost to partially disclose whether terms are favorable or unfavorable; and buyers, who directly observe price, can either 1 Hermalin et al's (2007) survey of the law and economics of contracts discusses these and related issues. accept or read (at a cost), and can resample sellers if they reject.…”

Standardization as a Solution to the Reading Costs of Form Contracts

“…In a recent paper, Che and Choi [2009] argue that Katz's result depends both the lack of competition between firms and the fact that all consumers are identical. They use a model in which some consumers care about the terms in the contract and others do not.…”

“…In this paper, I both challenge the robustness of the Che and Choi [2009] result and build upon the insight that drives it. First, I show that the Che and Choi result that firms offer a high quality contract with positive probability that some consumer read is driven by the fact that firms can only offer two contracts.…”

“…Anticipating this, the consumer will not read any contract. Che and Choi [2009] avoid this equilibrium by constraining the possible contracts. Because the firm can only offer two possible contracts that have a discreet difference in quality between them, the consumer knows before reading any contract that it will either be contract  or contract  Thus, the firm can commit to offer the consumer some surplus after reading the contract provided the contract turns out to be contract  by choosing a low enough price.…”