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A matter of interpretation: Ambiguous contracts and liquidated damages

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  • Grant, Simon
  • Kline, J. Jude
  • Quiggin, John

Abstract

We consider the optimality of liquidated damages contracts in a setting of contractual ambiguity and potential for disputes. We show that when parties are ambiguity averse enough, they will optimally choose liquidated damages contracts and sacrifice risk sharing opportunities.

Suggested Citation

  • Grant, Simon & Kline, J. Jude & Quiggin, John, 2014. "A matter of interpretation: Ambiguous contracts and liquidated damages," Games and Economic Behavior, Elsevier, vol. 85(C), pages 180-187.
    • Handle: RePEc:eee:gamebe:v:85:y:2014:i:c:p:180-187
    DOI: 10.1016/j.geb.2014.01.019
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    References listed on IDEAS

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    1. Yeon-Koo Che & Tai-Yeong Chung, 1999. "Contract Damages and Cooperative Investments," RAND Journal of Economics, The RAND Corporation, vol. 30(1), pages 84-105, Spring.
    2. Tai-Yeong Chung, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(5), pages 1031-1042.
    3. Sujoy Mukerji & Jean-Marc Tallon, 2001. "Ambiguity Aversion and Incompleteness of Financial Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 68(4), pages 883-904.
    4. Grant, Simon & Kline, J. Jude & Quiggin, John, 2012. "Differential awareness, ambiguity, and incomplete contracts: A model of contractual disputes," Journal of Economic Behavior & Organization, Elsevier, vol. 82(2), pages 494-504.
    5. Grant, Simon & Kline, J. Jude & Quiggin, John, 2014. "A matter of interpretation: Ambiguous contracts and liquidated damages," Games and Economic Behavior, Elsevier, vol. 85(C), pages 180-187.
    6. Oliver Board, 2008. "Object-Based Unawareness: Theory and Applications," Working Paper 378, Department of Economics, University of Pittsburgh, revised Mar 2009.
    7. Faruk Gul & Wolfgang Pesendorfer, 2014. "Expected Uncertain Utility Theory," Econometrica, Econometric Society, vol. 82(1), pages 1-39, January.
    8. Kim-Sau Chung & Oliver Board, 2007. "Object-Based Unawareness," Working Papers 2007-2, University of Minnesota, Department of Economics, revised 24 Aug 2007.
    9. Steven Shavell, 1980. "Damage Measures for Breach of Contract," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 466-490, Autumn.
    10. Mukerji, Sujoy, 1998. "Ambiguity Aversion and Incompleteness of Contractual Form," American Economic Review, American Economic Association, vol. 88(5), pages 1207-1231, December.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Grant, Simon & Kline, J. Jude & Quiggin, John, 2014. "A matter of interpretation: Ambiguous contracts and liquidated damages," Games and Economic Behavior, Elsevier, vol. 85(C), pages 180-187.
    2. Grant, Simon & Kline, J. Jude & Quiggin, John, 2012. "Differential awareness, ambiguity, and incomplete contracts: A model of contractual disputes," Journal of Economic Behavior & Organization, Elsevier, vol. 82(2), pages 494-504.
    3. Grant, Simon & Jude Kline, J. & Quiggin, John, 2018. "Contracting under uncertainty: A principal–agent model with ambiguity averse parties," Games and Economic Behavior, Elsevier, vol. 109(C), pages 582-597.
    4. Grant, Simon & Kline, Jeff & Quiggin, John, 2011. "Ambiguous contracts: a syntactic approach," Risk and Sustainable Management Group Working Papers 153052, University of Queensland, School of Economics.
    5. John Quiggin, 2023. "Seven types of ambiguity," Discussion Papers Series 662, School of Economics, University of Queensland, Australia.
    6. Chen Li, 2017. "Are the poor worse at dealing with ambiguity?," Journal of Risk and Uncertainty, Springer, vol. 54(3), pages 239-268, June.
    7. Matt Essen & John Wooders, 2020. "Dissolving a partnership securely," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 69(2), pages 415-434, March.

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    More about this item

    Keywords

    Ambiguity; Bounded rationality; Expected uncertain utility; Incomplete contracts; Liquidated damages;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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