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Expectation Damages, Divisible Contracts, and Bilateral Investment

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  • Susanne Ohlendorf

Abstract

This paper examines the efficiency of expectation damages as a breach remedy in a bilateral trade setting with renegotiation and relationship-specific investment by the buyer and the seller. As demonstrated by Edlin and Reichelstein (1996), no contract that specifies only a fixed quantity and a fixed per-unit price can induce efficient investment if marginal cost is constant and deterministic. We show that this result does not extend to more general payoff functions. If both parties face the risk of breaching, the first best becomes attainable with a simple price-quantity contract. (JEL D86, K12)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.99.4.1608
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File URL: http://www.aeaweb.org/aer/data/sept09/20061292_app.pdf
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 99 (2009)
Issue (Month): 4 (September)
Pages: 1608-18

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Handle: RePEc:aea:aecrev:v:99:y:2009:i:4:p:1608-18

Note: DOI: 10.1257/aer.99.4.1608
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Cited by:
  1. Schmitz, Patrick W., 2013. "Bargaining position, bargaining power, and the property rights approach," MPRA Paper 44953, University Library of Munich, Germany.
  2. Bragelien, Iver & Impink, Joost, 2014. "Relationship-Specificity, Bargaining Power Growth, and Firm Performance," Discussion Papers 2014/4, Department of Business and Management Science, Norwegian School of Economics.
  3. Sebastian Kranz, 2013. "Relational Contracting, Repeated Negotiations, and Hold-Up," Levine's Working Paper Archive 786969000000000676, David K. Levine.
  4. Göller, Daniel, 2012. "Expectation Damages and Bilateral Cooperative Investments," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62047, Verein für Socialpolitik / German Economic Association.
  5. Schmitz, Patrick W., 2013. "Incomplete contracts and optimal ownership of public goods," Economics Letters, Elsevier, vol. 118(1), pages 94-96.
  6. Göller, Daniel & Stremitzer, Alexander, 2014. "Breach remedies inducing hybrid investments," International Review of Law and Economics, Elsevier, vol. 37(C), pages 26-38.
  7. Kranz, Sebastian, 2013. "Relational Contracting, Repeated Negotiations, and Hold-Up," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 80047, Verein für Socialpolitik / German Economic Association.
  8. Hoppe, Eva I. & Schmitz, Patrick W., 2009. "Can Contracts Solve the Hold-Up Problem? Experimental Evidence," CEPR Discussion Papers 7205, C.E.P.R. Discussion Papers.
  9. Goldlücke, Susanne & Schmitz, Patrick W, 2011. "Investments as Signals of Outside Options," CEPR Discussion Papers 8366, C.E.P.R. Discussion Papers.

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