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Expectation Damages, Divisible Contracts, and Bilateral Investment

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  • Ohlendorf, Susanne

Abstract

We consider a bilateral trade setting with costless renegotiation and investment by both the buyer and the seller. Whether first best levels of relationship-specific investment can be induced by a simple contract depends on available breach remedies. As demonstrated by Edlin and Reichelstein (1996), a contract specifying an up-front transfer, a quantity and a per-unit price is in general not able to achieve the first best when the breach remedy is expectation damages. We show that this result is due to the linearity of the cost function in their counterexample, and does not extend beyond the linear case. If marginal cost is increasing, then at intermediate prices both parties face the risk of breaching, and the first best becomes attainable.

Suggested Citation

  • Ohlendorf, Susanne, 2006. "Expectation Damages, Divisible Contracts, and Bilateral Investment," Bonn Econ Discussion Papers 25/2006, University of Bonn, Bonn Graduate School of Economics (BGSE).
    • Handle: RePEc:zbw:bonedp:252006
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    References listed on IDEAS

    as
    1. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-785, July.
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    Cited by:

    1. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, September.
    2. Sebastian Kranz, 2013. "Relational Contracting, Repeated Negotiations, and Hold-Up," Levine's Working Paper Archive 786969000000000676, David K. Levine.
    3. Schmitz, Patrick W., 2013. "Incomplete contracts and optimal ownership of public goods," Economics Letters, Elsevier, vol. 118(1), pages 94-96.
    4. Goldlücke, Susanne & Schmitz, Patrick W., 2014. "Investments as signals of outside options," Journal of Economic Theory, Elsevier, vol. 150(C), pages 683-708.
    5. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
    6. Daniel Göller, 2014. "Expectation Damages and Bilateral Cooperative Investments," American Law and Economics Review, American Law and Economics Association, vol. 16(2), pages 473-498.
    7. Alessandro De Chiara, 2018. "Courts' Decisions, Cooperative Investments, and Incomplete Contracts," CEU Working Papers 2018_5, Department of Economics, Central European University.
    8. Schweizer, Urs, 2016. "Efficient incentives from obligation law and the compensation principle," International Review of Law and Economics, Elsevier, vol. 45(C), pages 54-62.
    9. Ohlendorf, Susanne & Schmitz, Patrick, 2009. "Signaling an Outside Option," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 281, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    10. Bragelien, Iver & Impink, Joost, 2014. "Relationship-Specificity, Bargaining Power Growth, and Firm Performance," Discussion Papers 2014/4, Norwegian School of Economics, Department of Business and Management Science.
    11. Schmitz, Patrick W., 2013. "Bargaining position, bargaining power, and the property rights approach," Economics Letters, Elsevier, vol. 119(1), pages 28-31.
    12. 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.

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    More about this item

    Keywords

    expectation damages; breach remedies; renegotiation; hold-up;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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