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Timing Problems in Contract Breach Decisions

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  • Triantis, Alexander J
  • Triantis, George G

Abstract

In contracts susceptible to efficient breach, each party has an American option to breach and pay damages rather than perform. She will repudiate early if the expected decrease in damages liability resulting from her partner's mitigation exceeds the expected value of the terminated contract, including the option to breach in the future. We show that each party has the incentive to repudiate earlier than socially optimal because expectation damages compensate the nonrepudiating party only for the loss of the completed exchange and not the value of its lost breach option. This inefficiency is particularly acute in long-term, fixed-price contracts in which the cost of performance to the promisor and the value to the promisee are volatile and uncorrelated. We explore various responses to this problem, including vertical integration, changes in contract remedies (including specific performance), flexible price provisions, and the capital structure of each party. Copyright 1998 by the University of Chicago.

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  • Triantis, Alexander J & Triantis, George G, 1998. "Timing Problems in Contract Breach Decisions," Journal of Law and Economics, University of Chicago Press, vol. 41(1), pages 163-207, April.
    • Handle: RePEc:ucp:jlawec:v:41:y:1998:i:1:p:163-207
    DOI: 10.1086/467388
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    1. Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
    2. Cesare Dosi & Michele Moretto, 2017. "Cost Uncertainty and Time Overruns in Public Procurement: a Scoring Auction for a Contract with Delay Penalties," Working Papers 2017.02, Fondazione Eni Enrico Mattei.
    3. Fan Zhang, 2008. "Dynamic Contract Breach," EAG Discussions Papers 200803, Department of Justice, Antitrust Division.
    4. Francesco Parisi & Barbara Luppi & Vincy Fon, 2011. "Optimal Remedies for Bilateral Contracts," The Journal of Legal Studies, University of Chicago Press, vol. 40(1), pages 245-271.
    5. Cesare Dosi & Michele Moretto, 2017. "Cost Uncertainty and Time Overruns in Public Procurement: a Scoring Auction for a Contract with Delay Penalties," Working Papers 2017.02, Fondazione Eni Enrico Mattei.
    6. Edward R. Morrison, 2007. "Bankruptcy Decision Making: An Empirical Study of Continuation Bias in Small-Business Bankruptcies," Journal of Law and Economics, University of Chicago Press, vol. 50(2), pages 381-419.
    7. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    8. 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.

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