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The Moral-Hazard Effect of Liquidated Damages: An Experiment on Contract Remedies

Author

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  • Sven Hoeppner
  • Lars Freund
  • Ben Depoorter

Abstract

Recent evidence suggests that liquidated-damages clauses provide efficiencyadvantages by crowding out contracting parties' deontological concerns about efficient breach. In this paper we highlight an important downside to damage stipulations by parties. Based on findings obtained in a controlled laboratory experiment, we suggest that express damage stipulations trigger negative reciprocity and moral hazard, reducing performance by contract promisors. Such negative effects are absent when damages are exogenously imposed. Moreover, our results indicate that when stipulating damages, contract parties attain less cooperative surplus than when they are subject to an exogenously imposed remedy. Principals, not agents, bear this loss.

Suggested Citation

  • Sven Hoeppner & Lars Freund & Ben Depoorter, 2017. "The Moral-Hazard Effect of Liquidated Damages: An Experiment on Contract Remedies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 173(1), pages 84-105, March.
    • Handle: RePEc:mhr:jinste:urn:sici:0932-4569(201703)173:1_84:tmeold_2.0.tx_2-5
    DOI: 10.1628/093245616X14785139251341
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    Citations

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    Cited by:

    1. Cason, Timothy N. & Friesen, Lana & Gangadharan, Lata, 2020. "Inter-firm social dilemmas with agency risk," European Economic Review, Elsevier, vol. 129(C).
    2. Florian Baumann & Tim Friehe & Pascal Langenbach, 2020. "Fines versus Damages: Experimental Evidence on Care Investments," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2020_08, Max Planck Institute for Research on Collective Goods, revised Mar 2024.

    More about this item

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • C25 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions; Probabilities
    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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