SEDUCTION BY CONTRACT: LAW, ECONOMICS, AND PSYCHOLOGY IN CONSUMER MARKETS. By Oren Bar-Gill. Oxford: Oxford University Press. 2012. Pp. xvi, 249. Cloth, $39; paper, $25.
Economic analysis and the rational actor model have dominated contracts scholarship for at least a generation. (1) In the past fifteen years or so, however, a group of behaviorists has challenged the ability of the rational choice model to account for consumer behavior. (2) These behaviorists are not trying to dismantle the entire enterprise. They generally accept the fundamentals of economic analysis but argue that the rational actor model can be improved by incorporating evidence of decisionmaking flaws that people exhibit.
Oren Bar-Gill (3) has been one of the foremost and influential proponents of a behaviorist take on contracts, and his recent book, Seduction by Contract: Law, Economics, and Psychology in Consumer Markets, is the culmination of these efforts. In the book, he portrays consumers as the targets of temptation. The tempters are credit card, subprime mortgage, and cell phone companies that structure contracts in ways that exploit the behavioral weaknesses of some consumers. They seduce by offering upfront lures like frequent-flier miles, interest-only payments, and ostensibly free cell phones. But these contracts also bury deferred penalties such as escalating interest rates and a bevy of fees. The later costs are a source of regret for consumers and, in Bar-Gill's view, may warrant regulation that can limit this undesirable seduction.
Bar-Gill builds his analysis around a framework that emphasizes the problems with contractual complexity and deferred costs. Complexity can obscure the content of contracts, and consumers may be overly optimistic about what they do not know. This effect, Bar-Gill argues, can lead people to make errors when they assess the value of a bargain (p. 10). Deferred costs, meanwhile, exploit the intense preference that some consumers may have for immediate gratification (pp. 21-23). This myopia leads them to underestimate whether and how often they will fall prey to the deferred fees that many consumer contracts impose.
Throughout the book, Bar-Gill recommends the same salve for both ills. Targeted disclosure, he argues, is a minimally intrusive way to improve consumer-purchasing decisions (pp. 32-43). It can correct optimism by alerting people to the cost of terms that may be buried in contracts, and it can minimize myopia by informing people about typical usage patterns.
In this Review, I contrast Bar-Gill's analysis of complexity and deferred costs with an analysis of these problems that uses a pure rational choice model. My goal is to evaluate which of these approaches fares better at explaining the necessarily limited evidence we have about consumer responses to contractual complexity and deferred costs. As will become clear, I think that what we learn from the behavioral take on myopia tells us more than would a behavioral perspective on contractual complexity. When it comes to dense and complex fine print, there are longstanding rational choice models that predict how people might respond to the high cost of learning what is in a contract. These models predict that people will not read consumer agreements and that contract quality will accordingly be low. I suggest that the problem of rational ignorance of contracts may be a more substantial problem than the misperception that Bar-Gill stresses.
As part of this exercise, I explain my skepticism that the improved disclosure Bar-Gill endorses will be the most effective way to regulate the problems he identifies with consumer contracts. (4) With regard to complexity, this skepticism comes from an argument that the rational choice model may best explain how consumers evaluate form contracts. These models of complexity predict that the failure of consumers to read contracts will substantially degrade the overall quality of contracts. If these models are correct, disclosing that low quality will not do much good. (5) The real culprit here is the high cost of learning contract terms. After a review of some proposals that follow from the rational choice model, (6) I include my own counterintuitive suggestion that making default rules more seller friendly may be a desirable way to improve outcomes.
When it comes to deferred costs and myopia, Bar-Gill has me convinced that these mistakes occur and that they may have a deleterious effect on welfare. I am not sure, however, how effective disclosure will be as a remedy. This problem is ultimately one of weakness of the will. Consumers know the high costs of making late payments or exceeding their allotted cell phone minutes, but they incorrectly believe that they will be able to exercise enough discipline to avoid these penalties. Given that consumers are able to deceive themselves into thinking that they will behave, I am not necessarily persuaded that telling them that they are likely to misbehave will have much of an effect. Stronger medicine may be necessary to change outcomes.
Before explaining my critiques in more detail, I should emphasize that my goal here is to bring some measured skepticism to parts of the book rather than to refute it in a fundamental way. Bar-Gill stands as one of the handful of distinguished scholars who has forced practitioners of law and economics to take behavioral concerns seriously. The methodical and thorough approach in this book shows why this is the case. Bar-Gill's analysis explores the predictions of the rational actor model and explains how they may fail to account for observed behavior in the consumer markets that he studies. He then assesses whether market-oriented solutions will likely be able to solve the problem, and, where he concludes that they will not, he advocates targeted interventions that may correct for the potential problems that behavioral biases pose. These are hard questions about issues that lack good data. While I disagree with Bar-Gill on some points, his book is likely to remain an important resource for those who want general insight into the application of behavioral concerns to contracts and for those who want a deep understanding of the credit card, mortgage, and cell phone markets that the book covers.
The remainder of this Review explores contractual complexity and deferred costs in separate Parts. In each, I briefly review Bar-Gill's arguments and evidence. I then evaluate those arguments against what a straightforward rational choice model would predict. I end each Part with thoughts about what sorts of remedies may be more effective than disclosure.
Bar-Gill begins Seduction by Contract with a chapter that introduces the methodological tools and assumptions that he will apply throughout his analysis. In his framework, there is a difference between the actual terms of a contract and the perceived terms of a contract (p. 9). The salience of contract terms, he argues, drives the difference between actual terms and perceived terms. If the terms of the contract are salient--that is, they stand out to consumers who properly understand and value those terms--the difference between the actual and perceived terms will be minimal (p. 18). But if the terms are not salient--meaning that they are not prominent and may be difficult to value--the difference between the actual value of the contract terms and the perceived value of the contract terms will be large (p. 25).
A core argument for Bar-Gill is that firms have an incentive to design contracts in a way that increases the wedge between the actual value and the perceived value of the contracts' terms. (7) He argues that firms can draft complex contractual language to make it difficult for consumers to perceive the value of those terms. A rational consumer will infer that the clauses that firms have packed into fine print are likely to favor the seller. Bar-Gill, however, argues that some consumers are irrational. As he puts it, "[I]mperfectly rational consumers will completely ignore the unread or forgotten terms or naively assume that they are favorable" (p. 21).
If consumers miscalculate the value of these terms, it can lead to over-consumption. Bar-Gill cites the complex rules that credit card companies sometimes use as an example. (8) He also marshals some evidence that consumers have difficulty understanding these terms and that this misunderstanding may lead them to price these terms incorrectly. (9) As a consequence, consumers may take on more credit than they should. The behavioral flaw is, in essence, that of consumers being irrationally optimistic about what they do not know. (10) As his technical appendix to the first chapter helpfully shows, those who are optimistic about the terms of contracts will enter into more contracts than is optimal. (11) This effect creates a welfare loss. (12)
Bar-Gill contrasts these behavioral costs with a rational choice account of complex contract terms. But I am not sure that he chooses the right target here. Rather than compare the welfare losses associated with rational choice models of unknown contract terms, he asks a different set of questions. He analyzes whether there could be any welfare-enhancing explanation for the terms that firms bury in the fine print. Unsurprisingly, he finds that double-cycle billing by credit card companies, balloon payments in mortgages, and cell phone penalties are unlikely to add value to contracts. (13)
This comparison asks what a fully informed consumer would think of terms that firms put in complex contracts. The problems created by complexity, however, derive from how consumers will respond to misperceiving or not knowing the terms of contracts. It is this difficulty that creates the welfare loss. The equivalent question under a rational choice framework would ask not how a fully informed consumer would price terms but how an incompletely informed consumer would...