Contracting in the shadow of a corrupt court

This paper presents an incomplete contracting model to show how judicial corruption and judicial favoritism can lead to distortions in agents' incentives to invest in relation-specific assets and cause inefficiency. I also show that while an increase in the judge's income always increases investment, it is possible that a strongly favoritism-reducing increase in the authority's propensity to monitor the judiciary can actually reduce, instead of increase, investment in equilibrium. The implications of these findings for the study of institutional reforms, the relationship between the institutional environment and institutional arrangements, and the political economy of connections are explored. (JEL: D 73, K 42, L 14, O 21).