Whither Contract Damages: Contracts with Bilateral Reliance, One-sided Private Information

Resumen This article explores the canonical contracting problem in a general set up of bilateral “selfish” reliance with post contractual one-sided asymmetric information, helping uncover the shape optimal contracts and the optimal damage remedies. The quantity choice of the traded commodity is initially binary, but later extended to a continuous case. Reliance by agents enhances individual valuations but is not contractible. If information concerning either valuation or cost accrues to one of the two contracting parties and remains private – neither observable to the other party nor even verifiable by court, dispute may arise in some state of the world and one party could contemplate anticipatory breach. This article categorically shows that in an asymmetric information scenario, a simple incomplete contract under a regime of court-imposed remedies, often fails to provide the right reliance incentive to both parties simultaneously. Additionally, a renegotiation does not help restore ex post efficiency, contrary to what happens in a symmetric information case. When the breach victim’s expectation interest is difficult to be determined by court, a direct revelation mechanism can solve the problem of moral hazard, but assessing expectation damages correctly turns out to be at odds with ex post efficiency, an issue that is also explored. We conclude that a party designed liquidated damage measure is unconditionally superior to all other court imposed damage remedies.