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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 paper 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 vs. Baxendale are efficient solutions to the problem of implementing complex exchange.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13960.

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Date of creation: Apr 2008
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Publication status: published as Surajeet Chakravarty & W. Bentley MacLeod, 2009. "Contracting in the shadow of the law," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 533-557.
Handle: RePEc:nbr:nberwo:13960

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  1. 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.
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  6. Jean Tirole, 1985. "Procurement and Renegotiation," Working papers 362, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. 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.
  8. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 94(4), pages 691-719, August.
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  13. McAfee, R Preston & McMillan, John, 1987. "Auctions and Bidding," Journal of Economic Literature, American Economic Association, vol. 25(2), pages 699-738, June.
  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. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
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  17. Simon Johnson & John McMillan & Christopher Woodruff, 2001. "Courts and Relational Contracts," NBER Working Papers 8572, National Bureau of Economic Research, Inc.
  18. 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.
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Cited by:
  1. Gani Aldashev & Imane Chaara & Jean-Philippe Platteau & Zaki Wahhaj, 2010. "Using the Law to Change the Custom," Working Papers, Fondazione Eni Enrico Mattei 2010.60, Fondazione Eni Enrico Mattei.
  2. Claudine Desrieux & Jean Beuve, 2011. "Relational contracts as a foundation for contractual incompleteness," Economics Bulletin, AccessEcon, vol. 31(3), pages 2030-2040.
  3. Patrick Bolton & Antoine Faure-Grimaud, 2009. "Satisficing Contracts," NBER Working Papers 14654, National Bureau of Economic Research, Inc.

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