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Cadillac Contracts and Up-Front Payments: Efficient Investment under Expectation Damages

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  • Edlin, Aaron S

Abstract

This article shows that up-front payments can eliminate the overinvestment effect identified by Shavell (1980), by controlling which party breaches a contract. At the same time, "Cadillac" contracts (contracts for a very high quality or quantity) can protect against underinvestment due to Williamsonian holdups. This combination provides efficient investment incentives when courts use expectation damages as a remedy for breach. The expectation damages remedy is therefore well-suited to multidimensional but one-sided investment problems, in contrast to specific performance, which is well-suited to two-sided but unidimensional investment problems. Copyright 1996 by Oxford University Press.

Suggested Citation

  • Edlin, Aaron S, 1996. "Cadillac Contracts and Up-Front Payments: Efficient Investment under Expectation Damages," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 12(1), pages 98-118, April.
    • Handle: RePEc:oup:jleorg:v:12:y:1996:i:1:p:98-118
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    1. Feldstein, Martin, 1995. "Fiscal policies, capital formation, and capitalism," European Economic Review, Elsevier, vol. 39(3-4), pages 399-420, April.
    2. Keith Head & John C. Ries & Deborah L. Swenson, 1994. "The Attraction of Foreign Manufacturing Investments: Investment Promotion and Agglomeration Economies," NBER Working Papers 4878, National Bureau of Economic Research, Inc.
    3. David Cutler, 1994. "Market Failure in Small Group Health Insurance," NBER Working Papers 4879, National Bureau of Economic Research, Inc.
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    Cited by:

    1. M'hand Fares, 2006. "Renegotiation Design and Contract Solutions to the Hold‐Up Problem," Journal of Economic Surveys, Wiley Blackwell, vol. 20(5), pages 731-756, December.
    2. David Martimort & Aggey Semenov & Lars Stole, 2017. "A Theory of Contracts with Limited Enforcement," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 84(2), pages 816-852.
    3. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
    4. Manuel Willington, 2013. "Hold Up Under Costly Litigation and Imperfect Courts of Law," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 29(5), pages 1023-1055, October.
    5. Alexander Stremitzer, 2012. "Standard Breach Remedies, Quality Thresholds, and Cooperative Investments," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 28(2), pages 337-359.
    6. Charles North, 2001. "Remedies for misrepresentation in applications in the presence of fraudulent intent," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 29(2), pages 162-176, June.
    7. Ishiguro, Shingo, 2002. "Endogenous Verifiability and Optimality in Agency," Journal of Economic Theory, Elsevier, vol. 105(2), pages 518-530, August.
    8. Schmitz, Patrick W., 2002. "Simple contracts, renegotiation under asymmetric information, and the hold-up problem," European Economic Review, Elsevier, vol. 46(1), pages 169-188, January.
    9. Gordanier, John & Miao, Chun-Hui, 2011. "On the duration of technology licensing," International Journal of Industrial Organization, Elsevier, vol. 29(6), pages 755-765.
    10. Susanne Ohlendorf, 2009. "Expectation Damages, Divisible Contracts, and Bilateral Investment," American Economic Review, American Economic Association, vol. 99(4), pages 1608-1618, September.
    11. Plambeck, Erica L. & Taylor, Terry A., 2004. "Implications of Breach Remedy and Renegotiation for Design of Supply Contracts," Research Papers 1888, Stanford University, Graduate School of Business.
    12. Patrick W. Schmitz, 2005. "Should Contractual Clauses that Forbid Renegotiation Always be Enforced?," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 21(2), pages 315-329, October.
    13. Ronen Avraham & Zhiyong Liu, 2006. "Incomplete Contracts with Asymmetric Information: Exclusive Versus Optional Remedies," American Law and Economics Review, American Law and Economics Association, vol. 8(3), pages 523-561.
    14. Rebecca Stone & Alexander Stremitzer, 2020. "Promises, Reliance, and Psychological Lock-In," The Journal of Legal Studies, University of Chicago Press, vol. 49(1), pages 33-72.
    15. Göller, Daniel & Stremitzer, Alexander, 2009. "Breach Remedies Including Hybrid Investments," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 282, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    16. Brooks, Richard & Stremitzer, Alexander, 2009. "On and Off Contract Remedies," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 290, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    17. Jean-Marc Bourgeon & Pierre Picard, 2017. "Nitpicky Insurers and the Law of Contracts," CESifo Working Paper Series 6669, CESifo.
    18. Erica L. Plambeck & Terry A. Taylor, 2007. "Implications of Breach Remedy and Renegotiation Design for Innovation and Capacity," Management Science, INFORMS, vol. 53(12), pages 1859-1871, December.
    19. Albert H. Choi & George Triantis, 2021. "Contract Design When Relationship-Specific Investment Produces Asymmetric Information," The Journal of Legal Studies, University of Chicago Press, vol. 50(2), pages 219-260.
    20. Thomas J. Miceli & Kathleen Segerson, 2014. "Opportunism in Sequential Investment Settings: On Holdups and Holdouts," Working papers 2014-08, University of Connecticut, Department of Economics.
    21. Richard R.W. Brooks & Alexander Stremitzer, 2012. "On and Off Contract Remedies Inducing Cooperative Investments," American Law and Economics Review, American Law and Economics Association, vol. 14(2), pages 488-516.

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    • L - Industrial Organization

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