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Regulating Damage Clauses in (Labor) Contracts

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  • Muehlheusser, Gerd

    ()
    (University of Hamburg)

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    Abstract

    We analyze the role of damage clauses in labor contracts using a model in which a worker may want to terminate his current employment relationship and work for another firm. We show that the initial parties to a contract have an incentive to stipulate excessive damage clauses, which leads to ex post inefficiencies. This result is due to rent seeking motives a) between the contracting parties vis-à-vis third parties and b) among the contracting parties themselves. We then show that, by imposing an upper bound on the amount of enforceable damages, a regulator can induce a Pareto improvement; in some cases even the first best can be achieved.

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    Bibliographic Info

    Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2367.

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    Length: 31 pages
    Date of creation: Oct 2006
    Date of revision:
    Publication status: published in: Journal of Institutional and Theoretical Economics, 2007, 163 (4), 531-551
    Handle: RePEc:iza:izadps:dp2367

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    Related research

    Keywords: asymmetric information; breach of contract; penalty doctrine; damage clauses; labor contracts;

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    References

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    1. Aghion, Philippe & Bolton, Patrick, 1987. "Contracts as a Barrier to Entry," American Economic Review, American Economic Association, vol. 77(3), pages 388-401, June.
    2. Roger B. Myerson & Mark A. Satterthwaite, 1981. "Efficient Mechanisms for Bilateral Trading," Discussion Papers 469S, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    3. Aghion, Philippe & Bolton, Patrick, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 473-94, July.
    4. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
    5. Stole, Lars A, 1992. "The Economics of Liquidated Damage Clauses in Contractual Environments with Private Information," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(3), pages 582-606, October.
    6. Steven Shavell, 1980. "Damage Measures for Breach of Contract," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 466-490, Autumn.
    7. Epstein, Richard A, 1989. "Beyond Foreseeability: Consequential Damages in the Law of Contract," The Journal of Legal Studies, University of Chicago Press, vol. 18(1), pages 105-38, January.
    8. Chung, T.Y., 1991. "On the Social Optimality of Liquidated Damage Clauses: An Economic Analysis," UWO Department of Economics Working Papers 9102, University of Western Ontario, Department of Economics.
    9. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
    10. Feess, Eberhard & Muehlheusser, Gerd, 2003. "Transfer fee regulations in European football," European Economic Review, Elsevier, vol. 47(4), pages 645-668, August.
    11. Hermalin, Benjamin E & Katz, Michael L, 1993. "Judicial Modification of Contracts between Sophisticated Parties: A More Complete View of Incomplete Contracts and Their Breach," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(2), pages 230-55, October.
    12. Dominique Demougin & Carsten Helm, 2006. "Moral Hazard and Bargaining Power," German Economic Review, Verein für Socialpolitik, vol. 7, pages 463-470, November.
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