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Regulating Damage Clauses in (Labor) Contracts


  • Gerd Muehlheusser


This paper analyzes 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. It is shown 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-a-vis third parties and (b) among the contracting parties themselves. Moreover, 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.

Suggested Citation

  • Gerd Muehlheusser, 2007. "Regulating Damage Clauses in (Labor) Contracts," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 163(4), pages 531-551, December.
  • Handle: RePEc:mhr:jinste:urn:sici:0932-4569(200712)163:4_531:rdcilc_2.0.tx_2-6

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    References listed on IDEAS

    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.
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    Cited by:

    1. Claudia M. Landeo & Kathryn E. Spier, 2016. "Stipulated Damages as a Rent-Extraction Mechanism: Experimental Evidence," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 172(2), pages 235-273, June.
    2. Bernhard Ganglmair, 2008. "Breakup of Repeat Transaction Contracts, Specific Investment, and Efficient Rent-Seeking," JEPS Working Papers 08-001, JEPS.

    More about this item

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • M31 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Marketing and Advertising - - - Marketing
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation


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