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On the Efficiency of Privately Stipulated Damages for Breach of Contract: Entry Barriers, Reliance, and Renegotiation

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  • Kathryn E. Spier
  • Michael D. Whinston

Abstract

Two roles for stipulated damage provisions have been debated in the literature: protecting relationship-specific investments and inefficiently excluding competitors. Aghion and Bolton (1987) formally demonstrate the latter effect in a model without investment or renegotiation. Although introducing renegotiation alone destroys their result, introducing both renegotiation and investment restores it. In particular, if an entrant has market power and the seller's cost of production is observable but not verifiable, then privately stipulated damages are set at a socially excessive level to facilitate the extraction of the entrant's surplus. In contrast, if the entrant prices competitively (as typically is assumed in the law and economics literature on breach), then private stipulation is efficient. Whereas a simple legal restriction on the contract corrects for any inefficiency, standard court-imposed remedies do not.

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Bibliographic Info

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

Volume (Year): 26 (1995)
Issue (Month): 2 (Summer)
Pages: 180-202

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Handle: RePEc:rje:randje:v:26:y:1995:i:summer:p:180-202

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Cited by:
  1. Ornelas, Emanuel & Turner, John L., 2010. "Protection and International Sourcing," CEPR Discussion Papers 8070, C.E.P.R. Discussion Papers.
  2. Schmitz, Patrick W., 2005. "Should Contractual Clauses that Forbid Renegotiation Always be Enforced?," CEPR Discussion Papers 5292, C.E.P.R. Discussion Papers.
  3. Landeo, Claudia M. & Spier, Kathryn E., 2007. "Naked Exclusion: An Experimental Study of Contracts with Externalities," MPRA Paper 9143, University Library of Munich, Germany.
  4. Che, Yeon-Koo & Spier, Kathryn, 2006. "Strategic Judgment Proofing," MPRA Paper 6100, University Library of Munich, Germany.
  5. Goller, Daniel & Stremitzer, Alexander, 2009. "Breach Remedies Inducing Hybrid Investments," Working Papers 72, Yale University, Department of Economics.
  6. Antonio Nicita & Massimiliano Vatiero, 2014. "Dixit versus Williamson: the ‘fundamental transformation’ reconsidered," European Journal of Law and Economics, Springer, vol. 37(3), pages 439-453, June.
  7. Charles North, 2001. "Remedies for misrepresentation in applications in the presence of fraudulent intent," Atlantic Economic Journal, International Atlantic Economic Society, vol. 29(2), pages 162-176, June.
  8. Muriel Fadairo & Jianyu Yu, 2014. "Economic Rationales of Exclusive Dealing ; Empirical Evidence from the French Distribution Networks," Working Papers 1405, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.
  9. Hua, Xinyu, 2012. "The right of first offer," International Journal of Industrial Organization, Elsevier, vol. 30(4), pages 389-397.
  10. Xinyu Hua, 2004. "Strategic Ex-ante Contracts: Rent-Extraction and Opportunity Costs," Econometric Society 2004 North American Summer Meetings 564, Econometric Society.
  11. Yongmin Chen & David E. M. Sappington, 2011. "Exclusive Contracts, Innovation, and Welfare," American Economic Journal: Microeconomics, American Economic Association, vol. 3(2), pages 194-220, May.
  12. Gratz, Linda & Reisinger, Markus, 2013. "On the competition enhancing effects of exclusive dealing contracts," International Journal of Industrial Organization, Elsevier, vol. 31(5), pages 429-437.

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