Contract Litigation as Information Revelation Channel and its Implications on Reputation (Dis)Incentives

Abstract

We examine how the reputation concern of contracting parties affects contractual incentives if information is transmitted to the public through contract litigation. In a career concern framework, the performance of the long-lived seller is revealed to future buyers only if contractual disputes are litigated. We show that the seller's reputation concern acts like an additional legal cost which induces her to settle privately. A strong reputation concern effectively voids the incentive contract and eliminates all incentives. Finally, we apply the model to discuss the optimal information disclosure policy of courts.