Contract Design in the Shadow of Regulation

• Publication year: 2021
• Citation: Vol. 98

98 Nebraska L. Rev. 874. Contract Design in the Shadow of Regulation

Contract Design in the Shadow of Regulation

James Fallows Tierney(fn*)

ABSTRACT

Does the threat of legal reform encourage companies to adopt high-quality contract terms that consumers ignore so that companies can use them in lobbying efforts to avoid reform? That may be an overlooked answer to a puzzle about consumer contracts. Consumers ignore most contract terms at the time of acceptance, so scholars usually expect companies to pick ignored terms of the lowest possible quality that courts will let them get away with. But some companies pick terms that are surprisingly high-quality. Courts do not require these terms that consumers ignore, so firms that pick them incur costs for seemingly little gain.

This Article identifies a novel function of these terms: their audience is not courts or consumers, but policymakers deciding whether to re-

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form status quo legal rules from which companies profit. Drawing on behavioral law and economics, and illustrating with a case study of lobbying surrounding the Consumer Financial Protection Bureau's bank account overdraft rule, this Article shows how companies use the high-quality terms they adopt in anticipation of regulation to "frame" the status quo rule. High-quality terms help show how the status quo rule might benefit consumers, letting companies appeal to policymakers' cognitive biases so they are more likely to support the status quo rule. This Article addresses several practical and theoretical implications of anticipatory self-regulation to frame reform. On one hand, even the threat of legal reform might influence the kinds of contract terms businesses adopt. On the other, a small minority of contract terms can take on outsized role in policy debates about legal reform, potentially distorting policymaking. As a theoretical matter, moreover, the Article complements information revelation models of sequential policymaking by showing how actors at one stage can frame information so policymakers at a later stage resort to decision-simplifying heuristics that favor the status quo.

TABLE OF CONTENTS

I. Introduction .......................................... 876

II. Unexpectedly High-Quality Nonsalient Terms ......... 880
A. The Expected Race to the Bottom .................. 881
B. Puzzling Examples of High-Quality Nonsalient Terms ............................................. 884
1. Overdraft Protection ........................... 885
2. Website Privacy Policies ....................... 889
3. Pro-Consumer Clauses in Relational Contracts of Adhesion .................................... 891
4. Do We See Anticipatory Self-Regulation Elsewhere? .................................... 892

III. Anticipatory Self-Regulation and Framing Effects ...... 893
A. Framing the Status Quo in Policy Discourse with Contract Terms ................................... 894
1. Framing Effects ............................... 894
2. Contract Terms' Salience to Policymakers ...... 897
B. Case Study: Using Anticipatory Self-Regulation to Frame Policy Choice ............................... 901
1. Status Quo Bias ............................... 902
2. Loss Aversion ................................. 904
3. Availability .................................... 906
C. A General Account of Anticipatory Self-Regulationto Frame Policy ................................... 908
D. Objections and Alternative Explanations ........... 912
1. Assessing Objections ........................... 912

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2. Alternative Explanations to Anticipatory Self-Regulation .................................... 915

IV. Implications .......................................... 917
A. Theoretical, Empirical, and Normative Implications ....................................... 917
B. Practical Implications for Policymakers and Reformers ......................................... 922

V. Conclusion ............................................ 924

I. INTRODUCTION

Contract designers work in the shadow of status quo legal rules.(fn1) Where those rules allow, firms can adopt contract terms that consumers ignore-"nonsalient" terms-to dump risk or increase the effective total price paid, even if the upfront price appears low. Consumers ignore these terms in entering into transactions; they are imperfectly rational, cannot effectively process complex contracts, are myopic, and overconfident about terms that will govern the present and future.(fn2) Many scholars expect firms will adopt self-serving terms whenever possible, subject only to enforcement constraints.(fn3)

Yet sometimes firms adopt terms that are puzzlingly high-quality from consumers' perspective.(fn4) For instance, a firm might include a term forbearing from a potential source of revenue-like posting transactions to a checking account in an order that does not maximize overdraft-fee revenue-that governing law otherwise allows. In examples like this,(fn5) the pattern is that the nonsalient term allocates more surplus, less risk, or more protection than we might expect, reducing the firm's opportunity for profit-for seemingly no gain.(fn6)

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One answer to the puzzle is an underappreciated public law implication of contract design: firms sometimes adopt terms for an audience of regulators or policymakers, rather than consumers or courts. When firms anticipate legal reform that would threaten a profitable term or practice, they may adopt contract terms that help them fend off reform. In doing so, firms can use high-quality terms to shape policymakers' perceptions about real-world consequences of what status quo rules let firms do. In short, a firm can fend off adoption of a mandatory rule prohibiting some profitable practice by adopting a high-quality term that gives back surplus with respect to only a small portion of that practice.

Terms that consumers ignore can still be relevant to policymakers because of their social consequences. Some terms affect consumers' or third parties' interests and legal rights. For example, Facebook's practice of collecting and selling user data may have influenced electoral outcomes.(fn7) Consumer groups, plaintiffs' attorneys, and other reformers might respond to events like these by publicizing the negative consequences of firms' contracts. That can be costly for firms-not just in reputation, but also in exposure to proposed reforms like mandatory rules that change what firms can and cannot do.(fn8) Reform proposals expand contracts' audiences to include the policymakers deciding whether to keep the status quo legal rule.(fn9) Firms that face significant risk from reform can pursue a midway strategy of anticipatory self-regulation: adopting apparently high-quality terms to show policymakers that market practices under the status quo rule benefit consumers, making reform undesirable. Firms can embed high-quality nonsalient terms within the broader low-quality term they seek to protect in the policy sphere.

Firms often use high-quality terms to influence policymakers' decisions by appealing to their imperfect rationality. Cognitive psychologists and behavioral economists have shown that people are imperfectly, rather than perfectly, rational.(fn10) We often use mental

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shortcuts in making choices, and can be susceptible to "framing effects"-the tendency to prefer one option based on how it is described or framed.(fn11) Policymakers are susceptible to framing effects, as mediated through certain heuristics and cognitive biases.(fn12) Firms can publicize high-quality terms in ways that frame the choice between status quo rules and reform, appealing to decision-simplifying heuristics and cognitive biases that encourage support for the status quo. If policymakers respond to this framing, they may prefer the status quo for reasons that may be only loosely related to an unbiased view of its normative desirability, potentially inhibiting reform.

In this Article, I aim to make two principal scholarly contributions about the important and unappreciated implications of framing reform using anticipatory self-regulation. First, I offer a novel theoretical account of how contract designers appeal to audiences other than courts and counterparties, both reacting to anticipated regulation and using their contract design to influence policymakers' choices.(fn13) This account ties together contract theory, collective choice of legal rules, and behavioral law and economics. If firms adopt contract terms in the shadow of anticipated reform, and use these terms to frame the status quo, they can influence how imperfectly rational policymakers perceive tradeoffs between the status quo rule and proposed reforms.(fn14) This Article thus fills a gap in the literature on how imperfect rationality bears on the selection of contract terms and legal rules.(fn15)

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Second, this Article raises implications for behavioral market failures in political economy. Firms influence consumer behavior through contract design that appeals to their psychology, and use similar strategies to influence policymakers' selection of rules governing markets for contract terms. Experimental evidence suggests that policymakers react favorably to firms' voluntary adoption of practices that go beyond the requirements of existing law, reducing their demand for reform.(fn16) One upshot is that a credible threat of reform can encourage firms to adopt contractual terms that, to a first-order approximation, begin to address some of the policy goals...