an economic theory of adverse possession

~ L I T T E R W O R T H m E I N E M A N N

An Economic Theory of Adverse Possession

THOMAS J. MICELI

Department of Economics U-63 University of Connecticut

and

C.F. SmMANS

Department of Finance U-41RE School of Business Administration University of Connecticut

I. Introduction

Under the doctrine of adverse possession, the occupier of a piece of land who is not the true owner nevertheless acquires title to the land if his occupation is hostile to the owner's interests, open and notorious, exclusive, and continuous for the statutorily required period of time.] Several justifications have been advanced for this curious doctrine, which has been enacted in some form by all fifty states. 2 The first is the standard reason for statutes of limitations--that evidence decays over time, making it difficult to try cases after some amount of time has elapsed. Second, owners should face a penalty (loss of their land) for sitting on their rights or otherwise using their land inetficiendy. Third, by eliminating old claims to property, transaction costs are reduced, thereby facilitating market exchange. Finally, adverse possessors who have occupied a piece of land for a long period may have developed considerable reliance interests that would be lost if the true owner could reclaim title at any time. These justifications make varying degrees of economic sense. For example, given modern land recording systems, the lost evidence problem is probably of minimal concern. Also, the presumption that land left idle by its owner is not being used optimally is not valid, given that the value of land is often maximized by waiting for the optimal time to develop.

The final two justifications for adverse possession make more economic sense. The fourth especially will play a prominent role in the theory developed in this paper. The problem with protecting the reliance interests of adverse possessors, however, is that it encourages "squatters" to make such investments as a way of acquiring title outside the market. Thus, we shall argue that this justification makes sense only in the case of inadvertent squatting, as when a boundary error occurs. In this case, we argue that allowing title to pass to the possessor after a certain period prevents the

We acknowledge the helpful comments of Jonas Rasimavicus and two anonymous referees.

International Review of Law and Economics 15:161-173, 1995 © 1995 by Elsevier Science Inc. 655 Avenue of the Americas, New York, NY 10010

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162 Economic theory of adverse possession

true owner from taking advantage of the possessor's initial error to extort quasi rents created by his reliance expenditures.

What this argument overlooks, of course, is that good faith errors are difficult, if not impossible, to distinguish from intentional boundary encroachment. We therefore argue that the structure of adverse possession must impose some penalty on possessors for making boundary "errors," both to deter intentional errors, and also to provide an incentive for land users to avoid good faith errors in the first place (e.g., by conducting surveys prior to developing). According to our theory, this penalty is the risk that land users face of losing their reliance expenditures if the true owner discovers a boundary error before the statutory period expires. The optimal statutory period balances this effect against the desire to prevent owners from ex- tracting excessive quasi rents.

Previous economic analyses of adverse possession are scarce. Ellickson (1986) de- termines the optimal statutory period by minimizing the total costs of land transfer, including transaction costs, monitoring costs, and the demoralization costs associated with the uncompensated loss of property by a true owner. 3 Merrill (1986) examines the doctrine in light of the distinction first proposed by Calabresi and Melamed (1972) between property rules and liability rules. Since Merrill's analysis touches on many aspects of the current theory, we discuss it in more detail below. Finally, Netter, Hersch, and Manson (1986) conduct an empirical analysis of state variations in adverse possession statutes. We also discuss their results below.

The paper is organized as follows. Section 2 lays out our theory of adverse possession based on the goal of minimizing the cost of boundary errors. Section 3 then relates the theory to Merrill's analysis. Section 4 examines the various elements of adverse possession in light of the theory and argues that they generally support it. Section 5 relates our theory of adverse possession to other areas of the law to show the pervasiveness of the problem that it addresses. Finally, section 6 concludes. For interested readers, an appendix employs a simple model to illustrate formally the results in the text.

II. The Theory

The typical adverse possession case involves a disputed boundary between neigh- boring landowners. Consider, for example, adjacent landowners A and B. Suppose A wishes to develop a portion of his property near the boundary with B, but the exact location of the boundary is uncertain. Prior to developing, therefore, it is efficient for A to conduct a survey to determine the location of the boundary (assuming that the survey does not cost more than the expected return from the development). Once the boundary is determined, A can safely develop on his own side of the boundary, or he can bargain with B to purchase a portion of her property if that is the efficient course of action. If, however, the boundary error is discovered after A develops, correcting it is costlier owing to A's committed resources. Thus, determining the boundary prior to development facilitates efficient land use and avoids costly bargaining ex post (the nature of which is described in detail below) if an error occurs.

It is inevitable, however, that some errors in boundary determination will occur. Either A will fail to conduct a survey under the presumption that he is developing his own land (e.g., due to an error in a previous survey), or the current survey will result in an error. Another possibility is that A intentionally encroaches on B's property. The theory of adverse possession to be developed in this section is based on the

T.J. MICELI AND C.F. 8IRMANS 163

premise that the law seeks to facilitate voluntary transfers of property to higher valuing users and, when errors in land use occur, to remedy those errors at lowest cost. Consistent with this objective is that the law seeks to deter involuntary transfers (as when A intentionally encroaches) because this is inconsistent with value enhanc- ing exchange. A significant problem to overcome, however, is that honest boundary errors by parties otherwise acting in good faith are difficult (if not impossible) to distinguish ex post from intentional encroachment. We will argue that the structure of adverse possession law is determined in large part to address this problem.

The analysis begins with the possibility, noted above, that honest errors in boundary determination are possible (the problem of intentional encroachment will be addressed below). Thus, suppose that A develops on a portion of B's property in the mistaken belief that he is developing entirely on his own property. Moreover, suppose that A's investment involves some nonsalvageable expenditures that will be lost if B discovers the error and ejects A from his property. For example, suppose A erects a structure that would have to be torn down. As a result of this sunk investment, the amount that A would pay to retain the disputed land after the structure is built exceeds the amount he would have paid to acquire it before the investment. The reason for the difference is that, when A makes the investment, he forgoes all other options that had been available (e.g., building in other locations or building a moveable structure). The additional value A places on the land after investing represents a quasi rent that B can attempt to appropriate (Klein, Crawford, and Alchian, 1978). In other words, if B discovers that A's structure is at least partially on her property, she can hold out for a much larger payment from A for the disputed land than if they had bargained before A developed. The additional amount B can hold out for just equals the nonsalvageable cost of the structure, or the quasi rent.

It is well-known that the existence of quasi rents leads to unproductive investments in rent-seeking behavior. For example, B will invest resources, beyond the efficient point, in an effort to discover boundary errors by A. Moreover, because one supposes that as time passes the amount of this quasi rent increases, either because A increases his investment in the land, or because he may simply become more "attached" to it in less tangible ways (or both), B will not have an incentive to correct boundary errors in a timely fashion. Using a tort analogy, B will not have an incentive to "mitigate the damages" arising from A's initial error, because she can profit by allowing the damages to increase. 4

Note that B's incentive to capture the quasi rents generated by A's sunk investment arises from her right to eject A from the land if no bargain is reached. B's right to eject A in turn stems from the fact that she has property rule protection of her land, which entitles her to turn down any offer to purchase it and for any reason (Calabresi and Melamed, 1972). Under normal circumstances, property rules enhance efficiency by guaranteeing that only mutually beneficial exchanges occur; indeed, property rules are the basis for market exchange. For example, if, prior to his investment, A had wished to purchase a portion of B's property, B's right to refuse any offer would ensure that A would actually acquire it only if he truly valued it more than B. Moreover, because A's valuation of the land at this stage is limited by his next best option (e.g., building at a different location), B cannot hold out for an excessive price without risking loss of a beneficial sale. (This represents the role of competition in restraining market power by B.) However, once A invests, his valuation of the land increases by the amount of the nonsalvageable cost, and the problem of appropriable quasi rents arises.


One remedy for this problem is to place a time limit on B's right to eject A from the disputed property. Specifically, suppose that after a certain period has elapsed, B can no longer demand that A vacate the property if a bargain is not reached. The benefits of this solution are, first, that it gives B an incentive to discover and correct A's e r ror in a timely fashion, thereby mitigating the damages incurred by A; and second, it reduces bargaining costs by limiting the period during which A must bargain with B.

The solution just proposed--a time-limited property rule for B--is not ideal because it still allows B to "extort" some quasi rent (albeit limited) from A. Thus, some rent-seeking expenditures will continue to occur. This threat actually serves a useful purpose, however, by providing A an incentive to uncover boundary errors before making sunk investments. In essence, it functions as a penalty to deter boundary errors ex ante. Because the magnitude of this penalty increases with the length of the time limit on B's property rule (assuming A's reliance on the disputed land increases with time), there now exists a trade-off in the determination of the optimal limit. A longer limit improves incentives for A to discover errors ex ante by increasing the penalty for failing to detect them (the first-best outcome), but, at the same time, it decreases the incentive for B to correct errors that inevitably occur ex post (the second-best outcome). The optimal limit balances these two effects.

The penalty function of allowing B to extort some quasi rents under a time-limited property rule can be illustrated by considering an alternative solution that eliminates the quasi-rent problem altogether. Suppose that B's land is protected by a liability rule rather than a property rule in cases of boundary encroachment by A (Calabresi and Melamed, 1972). A liability rule differs from a property rule in that the former does not give the entitlement holder the right to refuse a transfer, but only the right to receive payment for it ex post, where the payment is usually equal to the market value of the land taken. In boundary dispute cases, this implies that if A is found encroaching on B's land, A need not bargain at all with B but may simply pay B the market value of the land to acquire title to it. Thus, B's right to eject A, and thereby his ability to extract quasi rents, is eliminated.

Although this solution eliminates the problems associated with B's efforts to extract quasi rents from A under a property rule, it creates other problems. First, it may result in B's underspending to discover errors by A. This underinvestment will occur to the extent that a liability rule deprives B of any surplus she would have received from a "fair" bargain with A under a property rule (e.g., the outcome of a transaction prior to A's initial investment). Although the surplus that B could expect depends on the bargaining abilities of the parties, it is likely that she would receive some positive amount. (The amount B expects to receive therefore represents the value of her right to turn down an exchange under a property rule.)

A second, and more important, problem is that a liability rule removes any incen- five for A to avoid boundary errors in the first place. For example, suppose that, before developing the disputed land, A paid to have a survey done and discovered that B actually owned a portion of it. I f A truly valued the land more, then he could have purchased it in a voluntary transaction for a price less than A's valuation but greater than B's. As noted above, this is the efficient method of land transfer when transaction costs are low. Alternatively, A could simply have developed the land on the presumption that he owned it. I f B subsequently discovered the error, A could then purchase it, without B's consent, for an amount equal to the market value of the land. Clearly, this second strategy is cheaper for A in that he saves the cost of a survey

T.J. MICELI AND C.F. SIRMANS 165

and he pays less for the land, given that the market value is presumably less than B's valuation. ~ In addition, the cost of the land is discounted by the probability that B will not have sufficient incentive to discover the error and seek indemnification. As a result, "forced" land transfers of this sort are inferior to voluntary exchange in that movement o f land to higher valued uses is not assured. 6

The foregoing argument shows that protecting B's right with a liability rule following an encroachment by A imposes no penalty on A for the initial er ror and thereby offers inadequate incentives for him to avoid it in the first place. More important, it creates an incentive for A to encroach on B's land intentionally, because this is a cheaper means for acquiring the property. Of course, this incentive to circumvent the market is undesirable both for efficiency and fairness reasons, thus making liability rules undesirable in boundary error cases.

III. Merrill 's Proposed Rule

To this point, we have argued that a time-limited property rule, which resembles the actual structure of adverse possession, can be seen as a second-best solution to the problem of boundary errors. In a recent article, Merrill (1986) discussed a system of adverse possession that combines a time-limited property rule of the sort just described with a liability rule. Under this system, following A's encroachment on B's land, B would have property rule protection of her land for a limited period during which she can eject A, but when the time limit expires, B would have liability rule protection. That is, B would lose the right to eject A, but would retain the right to be compensated at fair market value. In short, B's property rule would become a liability rule when the statute of limitations expires.

In view of the above theory, the question is whether this system retains the desirable attributes of the time-limited property rule alone. It appears that it does, though the optimal time limit on the property rule may differ. To see this, first consider B's incentives to discover errors by A once investments are made. Because B has property rule protection during the statutory period, there remain appropriable quasi rents if an error is found. Thus, there still exists an incentive for B to uncover errors, despite the addition of a liability rule following the statutory period. However, in this case, the cost to B of not discovering the error before the statute of limitations expires is smaller because it is now the difference between the quasi rents and the market value of the property. As a result of this reduction in B's incentive to discover errors, the optimal time limit on the property rule may have to be shortened.

Consider next A's incentive to avoid errors in the first place (recall that this was where the problem with the liability rule arose above). Once again, the fact that B has property rule protection for the statutory period, and hence has the right to eject A during that time, continues to threaten A with a penalty for failure to avoid boundary errors in the first place. The impact of adding the liability rule following the statutory period is actually to increase the penalty for failing to avoid an error (compared to the time-limited property rule alone) because once the statutory period has run, A does not receive title free and clear. Instead, he must pay B the market value of the land (if B seeks indemnification). This effect would also tend to shorten the optimal time limit during which B retains property rule protection.

The addition of liability rule protection for B following expiration of the statute of limitations therefore does not seem to qualitatively alter the incentive effects of adverse possession as set forth above. Moreover, it would presumably increase the


appeal of the doctrine from a fairness perspective in that dispossessed owners would be compensated for their property. On the other hand, it would increase the costs of litigating adverse possession cases in at least two ways. First, there would be more cases because long-lost owners would have the right to seek compensation well after they had lost the right to eject possessors (though this cost could be reduced to some extent by limiting the period during which owners had the right to seek compensation, e.g., by limiting the duration of the liability rule as well). Second, cases for compensation would be more costly because they would require courts to determine the fair market value of properties at possibly remote times in the past. This is based on the idea that the appropriate measure of value is what the property was worth when the encroachment first occurred. This could present considerable problems of lost evidence (Merrill, 1986). In sum, adding a liability rule onto the time-limited property rule scheme in adverse possession cases, while possibly appealing from a fairness perspective, would entail a substantial increase in administrative costs.

IV. Comparison of Adverse Possession Law and the Theory

This section examines the principal features of adverse possession law in light of the above theory. Recall that, for an individual to acquire title by adverse possession, five elements must be present: possession must be (1) hostile and under claim of right; (2) actual; (3) open and notorious; (4) continuous; and (5) exclusive. 7 We examine each of these elements.

Hostile Possession and Under a Claim of Right

Hostile possession in this context means possession without permission of the owner and with an intention of claiming ownership. There has been some debate, however, over what constitutes a sufficiently hostile claim of right, especially in regard to the importance of the possessor's intent. This controversy is portrayed by the conflict

8 between the so-called Maine and Connecticut rules. The older Maine rule holds that mistaken possession cannot ripen into title because it lacks sufficient hostility (the argument is that, if the possessor were not mistaken about the boundary, he would not have encroached). In contrast, the newer Connecticut rule, which has become the majority view, holds that the possessor's state of mind is immaterial; the mere act of possession is hostile and represents sufficient notice to the owner of the possessor's claim of title. The obvious appeal of the Connecticut rule is that it does not require knowledge of the possessor's state of mind, which is both unobservable and easy to misrepresent. 9

Note that under either the Maine or Connecticut rule, an intentional encroacher should, in theory, prevail. Despite this fact, in a recent study of adverse possession cases during the period 1966-1983, Helmholz (1983) found that courts do inquire into the possessor's motives, and when there is evidence of intentional occupation (i.e., occupation by A in the knowledge that the land was truly B's), they generally rule against the possessor. In contrast, when the occupation was the result of a good faith error (or there is no evidence either way), they rule for the possessor. This suggests that courts have in effect adopted the Connecticut rule for the typical case, but when the evidence exists, they invoke the converse of the Maine rule.

How does this finding fit with the theory developed here? In deriving the theory, we implicitly assumed that courts could not distinguish intentional from uninten-

T.J. MICELI AND C.F. SmMANS 167

tional encroachments after the fact. This assumption was the basis for the idea that A must be "penalized" for failing to avoid "errors" (the penalty being the threat of losing quasi rents to B). This is consistent with the Connecticut rule. Recall, however, that this penalty was limited to induce B to correct true errors by A in a timely manner. Suppose that in this context, courts occasionally can observe when A did not make a good faith error but acted intentionally. In such cases, there is no benefit to be gained by limiting the penalty on A, because the encroachment was an intentional attempt to acquire title. However, the benefits of extending the limit (deterrence of intentional encroachments) are great. Thus, the optimal time limit should increase, which is exactly what the courts apparently are doing by rejecting the Maine rule and not awarding title to adverse possessors who acted with intent. Moreover, it is not surprising that this feature of adverse possession is the exception since, as noted above, intent is easily concealed and is therefore unobservable in the typical case.

Actual, Open, Notorious, and Exclusive Possession

The requirements that possession be actual, open, notorious, and exclusive for it to ripen into title are clearly designed to give the true owner ample opportunity to discover the encroachment and expel the possessor. This is consistent with the idea that most encroachments are the result of good faith errors, and the objective is to correct the error quickly before the possessor invests heavily in reliance. Some states require the presence of improvements or enclosure for the possessor to satisfy the open and notorious requirement. 1° This also conforms with the theory, because improvements are the primary source of appropriable quasi rents. 11 Thus, if no improvements are present, there is less need to protect the possessor's interest as opposed to the owner's.

The one situation in which actual possession of the land is not necessary for title to ripen is when the possessor has "color of tide"; that is, when he has a document that seems to confer title but that is defective. (In this case, "constructive" possession is sufficient.) In some states, color of title is necessary for an adverse possession claim; in others, it reduces the statutory period; and in all cases it is helpful evidence for the possessor.~2 The fact that color of title makes an adverse possession case easier to win is sensible; first, because it is less likely that the encroachment was intentional, and second, because it is more likely that the possessor will have invested in the property (in reliance on the defective tide), thereby making himself more susceptible to rent extraction by the true owner.

Continuous Possession

The final requirement for an adverse possession case is that possession must be continuous for the statutory period. If there is a break in the possessor's occupation, the statutory period ceases to run and must start anew if the possessor reoccupies the landfl s The requirement of continuity is consistent with the theory, in that abandonment by the possessor is a sign, first, that he did not occupy it erroneously, and second, that he has little reliance interest in the property.

Although abandonment violates the continuity requirement, sale or bequest of the property by the possessor does not. That is, a buyer or inheritor can claim title by "tacking" his period of occupancy to that of predecessors to satisfy the statutory period. 14 In terms of the theory, tacking differs from abandonment in that it does not


signal an absence of reliance by the seller, because he can capture the capitalized value of any improvements in the sale price. Further, the act of conveyance both signals the possessor's claim of title in an open way and provides an opportunity for title errors to be discovered. In addition, if tacking were not allowed, owners would in effect be given a longer period during which to allow accumulation of appropriable quasi rents by the sequence of possessors.

Variation in Adverse Possession Statutes Across States

To this point, we have focused on explaining the general characteristics of adverse possession statutes in light of the theory. Although the statutes in most states share these features, there is some variation, as the discussion in this section has indicated. This is not surprising because, although the basic trade-off underlying adverse possession is the same, the magnitude of the particular costs and benefits will likely vary cross-sectionally and over time.

A recent study by Netter, Hersch, and Manson (1986) has examined empirically the determinants of state variation in adverse possession statutes. Because it is the easiest component to measure, they focused on the length of the statutory period as a proxy for the overall "stringency" of the adverse possession requirements. Their hypothesis (which is consistent with our theory) was that the statutory period will be longer the costlier it is for true owners to identify and eject encroachers from their property, and shorter the greater are the benefits from facilitating land transfer. 15 Their results provide support for this hypothesis.

V. Comparison to Other Legal Doctrines

The general structure of the problem we have been examining (and to which adverse possession is a solution) is a situation where two parties, acting in sequence, can take steps to prevent a particular event from occurring. In the typical situation, the party moving first is in the best position to avoid the event, and therefore should attempt to do so. This is the first-best outcome. However, if the first party fails to avoid the event for some reason, it is then desirable for the second party to take steps to avoid the event or mitigate its effects. This is the second-best outcome. Problems of this sort involving sequential inputs arise in a variety of legal contexts, and the law has developed methods for resolving them.16 This section briefly reviews some of these remedies by way of placing our theory of adverse possession in broader context within the law and economics literature.

Nuisance Law

A well-known case in the law and economics literature is Boomer v. Atlantic Cement Co., 17 which involved a polluting cement factory that created a nuisance for nearby residents. The residents brought suit for an injunction to shut the factory down, but instead the court awarded money damages. Thus, the judge opted to protect the residents' fight to be free from the nuisance with a liability rule rather than a property rule. His reasoning was that property rule protection (an injunction) would have allowed the residents to shut the factory down, entailing a loss far in excess of the residents' collective damages. In contrast, awarding damages would allow the factory to stay open. Of course, the injunction need not have resulted in the factory shutting


down if the factory and residents could have struck a bargain. However, the large costs of a shutdown for the factory would have put the residents in a position to appropriate quasi rents.

This situation resembles the encroachment problem beginning from the point where party A has mistakenly developed on B's property. In this situation, recall, a property rule puts B (the residents) in a position to extort a payment from A (the factory) theoretically up to the cost of A's sunk investment. More important, it encourages rent seeking by both parties, by B to obtain the payment and by A not to make it. Use of a liability rule (damages) in the Boomer case eliminates this problem for the factory just as it did for party A above. However, a liability rule also creates the same offsetting problem--the cement company, like party A, no longer has an incentive to avoid the damages in the first place; for example, by considering alter- nate locations or by bargaining with residents ex ante. Thus, a trade-off exists between injunctive relief vs. damages: the former gives the cement company an incentive to avoid the harm optimally ex ante, while the latter minimizes rent-seeking behavior ex post. The optimal rule in a given case minimizes the combined costs.

Accident Law

Similar sequential choice problems arise in the context of accident law (Shavell, 1983). For example, the doctrine of last clear chance holds that the last party who could have reasonably avoided an accident liable for the damages, despite the possible antecedent negligence of the first party, is The intent of the doctrine clearly is to provide the last actor an incentive to compensate for previous (inadvertent) negligence by the first actor. This corresponds to efforts of party B in adverse possession cases to correct mistaken boundary encroachments by party A in a timely manner. However, the problem with holding the last actor fully liable is that it reduces the incentives for the first party to take optimal precaution. That is, it invites "strategic" negligence (Grady, 1988). Thus, in applying last clear chance, courts have to balance the benefits of inducing compensating precautions by the second actor in those cases where the first has been "inadvertently," negligent, against the risk of encouraging strategic negligence by the first actor. This is the same trade-off, recall, that determined the optimal limitation on B's property rule protection according to the theory above.

Contract Law

A similar problem arises in contract law in the context of breach of contract cases. Suppose, for example, that victims of breach expect to receive damages equal to their full losses in the event of breach (as under an expectation damage remedy). Note that such a rule gives promisees no incentive to limit their damages efficiently, for example, by not overrelying on the contract (Shavell, 1980). The potential victim of breach in this case thus corresponds to party A above, the inadvertent encroacher. Ex ante, both are in the best position to minimize damages--the breach victim by not overrelying, and the encroacher by surveying his property and not developing too near his boundary with B. Contract law discourages promisees from overrelying by lim-

2 u iting their damages to those reasonably foreseeable to the promisor. Thus, if a promisee overrelies, he will not be able to collect the full amount of his losses. The


trade-off is that damages cannot be limited so much that the promisor's incentives to breach are increased.

An additional problem that arises from limiting damages for breach is that breach thereby becomes a poor substitute for performance for the promisee (especially when litigation costs are factored in). When this is the case, promisors can threaten to impose costs on promisees by breaching, and then use that threat to obtain more favorable contract terms. This corresponds to the problem of rent seeking discussed above, and represents another offsetting cost of limiting damages for breach of contract (Goldberg, 1985). One way courts can dispense with problems that arise when damage remedies are not good substitutes for performance for promisees is by adopting contract law's version of a property rule--namely, specific performance. Under specific performance, the court does not allow the promisor to breach the contract but instead orders performance according to the original terms. However, the same problem that arose under an injunction in the Boomer case plagues specific performance--if performance is very costly for the promisor, the prom~ee in this case can hold out for quasi rents to excuse performance. ~1 The potential result again is wasteful rent seeking by both parties.

VI. Conclusion

At first glance, adverse possession is a puzzling doctrine from an economic point of View, because it validates coerced exchanges (under certain conditions) in a market where transaction costs are generally thought to be low. Explanations based on high transaction costs are, therefore, on the whole, unconvincing. This paper has instead provided a theory of adverse possession based on the goal of minimizing the cost of boundary errors. According to this theory, the objective of the doctrine is, first, to induce landowners to avoid boundary errors prior to making nonsalvageable investments in their land, and second, to induce "victims" of errors, when they occur, to correct them in a timely fashion. The elements of adverse possession broadly con- formed with this theory.

Appendix

This appendix develops a simple model to demonstrate the basic theory described in section II. Suppose A wishes to build a structure near his border with B, but there is some uncertainty about where the border actually is. In particular, suppose there is a disputed strip of land. Let m be the value A attaches to that strip prior to construc- tion, and let n be the value B attaches to it, where m > n. Further, suppose that if A learned that B owned the strip, A would purchase it for some price p ~ [n,m]. As noted, A's interest in the land is to build a structure whose value, once complete, is V > m. Assume that V is completely nondivisible and nonsalvageable. Thus, if A builds without first confirming or acquiring ownership and B subsequently discovers that the structure is partially on her property, A would pay up to V to acquire the land. Let the amount he actually pays be R ~< V.

In this setting, consider first A's incentive to conduct a survey prior to construc- tion. Let q be A's assessment of the probability that the strip in question is his, and let s be the cost of a survey. The expected value of a survey is thus given by

- s + qV + (1 - q)(V - p) = V - (1 - q)p - s. (A1)

T.J. MICE.LI AND C.F. SIRMANS 171

On the other hand, the expected value of building without first surveying is given by

qV + (1 - q)[a(V - R) + (1 - a)V] = qV + (1 - q)(V - aR), (A2)

where a is the probability that B conducts a survey. I t follows that A will conduct a survey before building if (A1) exceeds (A2), or if

(1 - q)(aR - p) > s, (A3)

where we assume R > p. I f A builds the structure without first acquiring the strip f rom B, B can then

conduct her own survey to determine ownership. She will do so, if the following condition is met

(1 - r)R > s, ( A 4 )

where r is B's assessment of the probability that the land is A's. (Note that the variable a in conditions (A2) and (A3) is based on this condition.)

The presumed social benefit o f a survey by B is that it may correct boundary errors missed (or made) by A. However, B's incentive to survey may be too great because of the appropr iable quasi rents, which are reflected by the fact that R > p. Moreover, since we argued in the text that A's at tachment to the land, and hence R, will grow over time, B may delay in correcting errors to extract greater quasi rents. 2~ A limit on the time period dur ing which B can eject A (i.e., a time limit on B's proper ty right) reduces the magnitude of this problem by essentially putting an uppe r bound on R.

T h e trade-off arising f rom such a limit can be seen by examining condition (A3). Note that as the magni tude of R is limited, (A3) becomes less likely, both directly because of the limit on R, and indirectly because a decreases (i.e., (A4) is less likely as R falls). As a result, by limiting B's ability to extract quasi rents ex post, A's incentive to conduct a survey ex ante is also reduced. Indeed, it is the fact that R > p that gives A an incentive to conduct the survey at all. The optimal limit on R thus balances the desire to give A an incentive to conduct a survey before building, and the cost o f excessive surveying by B when A fails to survey.

T h e preceding analysis also shows why protecting B's land with a liability rule ra ther than a proper ty rule will not induce A to survey ex ante and, therefore, will encourage nonmarket acquisitions. Specifically, note that if B could only collect the land's marke t value, p, instead of R, ex post, then (A3) would never hold. Thus, A must face the possibility of paying some quasi rents under threat o f ejectment to find a survey desirable.

N o t e s

1. See, e.g., Siedel (1979) and Mascolo (1992). 2. These justifications are discussed in greater detail by Merrill (1986). 3. See Michelman (1967), who developed the idea of demoralization costs in the context of un-

compensated government takings. 4. See the further discussion of the analogy between adverse possession and torts in section V

below. 5. A therefore saves the difference between B's valuation and the market value, as well as any

surplus above his valuation that B could have bargained for. 6. When transaction costs are high, however, liability rules may enhance etficiency to the extent that


voluntary exchange will not occur. See Calabresi and Melamed (1972). However, we assume throughout the current analysis that transaction costs are low.

7. See, e.g., Seidel (1979: 323-327). 8. See, e.g., Helmholz (1983: 339-341) and Mascolo (1992: 306-308). Also see the discussion of this

conflict in Predham v. Holfester, 108 A.2d 458 (1954). 9. This view is consistent with Holmes's philosophy that the law should not be conditioned on

unobservable factors (Holmes, 1881). It is also an important feature of the economic theory of the law, because it economizes on administrative costs.

10. Seidel (1979: 325). Other states simply require acts of ownership consistent with the character of the land in question. See e.g., Monroe v. Rawlings, 49 N.W.2d 55 (1951).

11. Generally, encroachment by a building is sufficient for the builder to obtain title if the building is of a "substantial and permanent nature" (3 Am Jur 2d, Adverse Possession §65 [1986]). This is consistent with the idea that a permanent building is a source of greater quasi rents than a moveable building. It is also consistent with the conjecture of a referee that a possessor's case will turn (in part) on the value of improvements, which is another proxy for quasi rents.

12. See Browder, et al. (1979: 35). 13. What constitutes a sufficient break in continuity is a case-specific issue. See Mascolo (1992:

312-316). 14. See, e.g., Brand v. Prince, 324 N.E.2d 314 (1974). To avoid a break in continuity, tacking requires

privity between the possessors (3 Am Jur 2d, Adverse Possession §87 [1986]). 15. As measures of these explanatory variables, they use the value of taxable property as a proxy for

the benefit of land transfer, and the change in population density as a proxy for monitoring COSts.

16. On the general problem of sequential inputs in legal contexts, see Wittman (1081). 17. 26 N.Y.2d 210, 257 N.E.2d 533, 324 N.Y.S.2d 312 (1970). The discussion of this case in the

current context is based on Goldberg (1985). 18. See, e.g., Greear v. No~nd, 89 S.E.2d 49 (1055). Last clear chance originated with the English case

of Dames v. Mann, 10 M. & W. 546, 156 Eng. Pep. 588 (1842). Its use has declined in the United States as most states have adopted comparative negligence in cases where last clear chance was once applied.

19. See Grady (1984: 422) for a similar analysis of the "direct consequences doctrine" of proximate cause. The same trade-off is addressed by the limitation of damages in accident cases to those that the victim could not have reasonably avoided (8havell, 1087:145-146). The purpose of this limitation is to provide an incentive for victims, once injured, to take efficient steps to mitigate their damages.

20. This rule originated in the case of H~ley v. Baxer~ale, 9 Ex. 341, 156 Eng. Rep. 145 (1954). See Cooter and Ulen (1088: 308-309) and Bebchuk and $havell (1991).

21. Notice, therefore, that the promisor can extract quasi rents under a damage remedy that un- dercompensates the promisee compared to performance, and the promisee can similarly extract quasi rents from the promisor under specific performance when performance is cosily.

22. This assumes that the growth in A's attachment exceeds B's discount rate.

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an economic theory of adverse possession

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