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Contracting in the shadow of the law

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  • Surajeet Chakravarty
  • W. Bentley MacLeod

Abstract

Economic models of contract typically assume that courts enforce obligations based on verifiable events (corresponding to the legal rule of specific performance). As a matter of law, this is not the case. This leaves open the question of optimal contract design given the available remedies used by the courts. This article shows that American standard form construction contracts can be viewed as an efficient mechanism for implementing building projects given existing legal rules. It is shown that a central feature of these contracts is the inclusion of governance covenants that shape the scope of authority and regulate the ex post bargaining power of parties. Our model also implies that the legal remedies of mistake, impossibility and the doctrine limiting damages for unforeseen events developed in the case of Hadley v. Baxendale are efficient solutions to the problem of implementing complex exchange. Copyright (c) 2009, RAND..

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Bibliographic Info

Article provided by RAND Corporation in its journal The RAND Journal of Economics.

Volume (Year): 40 (2009)
Issue (Month): 3 ()
Pages: 533-557

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Handle: RePEc:bla:randje:v:40:y:2009:i:3:p:533-557

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  1. Mathias Dewatripont & Philippe Aghion & Patrick Rey, 1994. "Renegotiation design with unverifiable information," ULB Institutional Repository 2013/9591, ULB -- Universite Libre de Bruxelles.
  2. Lucian Arye Bebchuk & Steven Shavell, 1991. "Information and the Scope of Liability for Breach of Contract: The Rule of Hadley V. Baxendale," NBER Working Papers 3696, National Bureau of Economic Research, Inc.
  3. Bajari, Patrick & Tadelis, Steven, 2001. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 387-407, Autumn.
  4. Roger B. Myerson, 1977. "Incentive Compatability and the Bargaining Problem," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 284, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Grossman, Sanford J. & Hart, Oliver D., 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Scholarly Articles 3450060, Harvard University Department of Economics.
  6. Chung, Tai-Yeong, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 58(5), pages 1031-42, October.
  7. Anderlini, Luca & Felli, Leonardo, 1994. "Incomplete Written Contracts: Undescribable States of Nature," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(4), pages 1085-1124, November.
  8. Oliver Hart & John Moore, 1985. "Incomplete Contracts and Renegotiation," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 367, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. McAfee, R Preston & McMillan, John, 1987. "Auctions and Bidding," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 25(2), pages 699-738, June.
  10. repec:att:wimass:9714 is not listed on IDEAS
  11. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, American Economic Association, vol. 89(1), pages 125-147, March.
  12. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 368, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, Econometric Society, vol. 67(4), pages 741-782, July.
  14. MacLeod, W Bentley & Malcomson, James M, 1993. "Investments, Holdup, and the Form of Market Contracts," American Economic Review, American Economic Association, American Economic Association, vol. 83(4), pages 811-37, September.
  15. Jean Tirole, 1985. "Procurement and Renegotiation," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 362, Massachusetts Institute of Technology (MIT), Department of Economics.
  16. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  17. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 83-114, January.
  18. Simon Johnson & John McMillan, 2002. "Courts and Relational Contracts," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 18(1), pages 221-277, April.
  19. Shaked, Avner & Sutton, John, 1984. "Involuntary Unemployment as a Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, Econometric Society, vol. 52(6), pages 1351-64, November.
  20. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
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Cited by:
  1. Aldashev, Gani & Chaara, Imane & Platteau, Jean-Philippe & Wahhaj, Zaki, 2012. "Using the law to change the custom," Journal of Development Economics, Elsevier, Elsevier, vol. 97(2), pages 182-200.
  2. Patrick Bolton & Antoine Faure-Grimaud, 2009. "Satisficing Contracts," NBER Working Papers 14654, National Bureau of Economic Research, Inc.
  3. Claudine Desrieux & Jean Beuve, 2011. "Relational contracts as a foundation for contractual incompleteness," Economics Bulletin, AccessEcon, vol. 31(3), pages 2030-2040.

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