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Contract Damages and Investment Dynamics

  • Tai-Yeong Chung
  • Alan Chan

The present article provides an economic analysis to examine how contract damages affects both breach and investment decisions over time. Unlike the standard static model, this article studies a model in which, upon signing a contract, a seller invests over two periods, and a buyer may breach at the end of each period. The dynamic structure of the model allows us to investigate investment dynamics under alternative contract damages. First, under expectation damages, the seller has an incentive to invest only in the first period (front-loading of investment). Second, under reliance damages, a similar front-loading of investment occurs, and the degree of front-loading is excessive relative to the expectation damages. Third, under restitution damages, the seller has an incentive to invest only in the second period. We also examine efficiency properties of new hybrid measures of damages in which damages depend on the timing of breach.

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Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 683.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:feam04:683
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  1. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  2. William P. Rogerson, 1984. "Efficient Reliance and Damage Measures for Breach of Contract," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 39-53, Spring.
  3. Edlin, Aaron S & Reichelstein, Stefan, 1996. "Holdups, Standard Breach Remedies, and Optimal Investment," American Economic Review, American Economic Association, vol. 86(3), pages 478-501, June.
  4. Yeon-Koo Che & Tai-Yeong Chung, 1999. "Contract Damages and Cooperative Investments," RAND Journal of Economics, The RAND Corporation, vol. 30(1), pages 84-105, Spring.
  5. Mahoney, Paul G, 1995. "Contract Remedies and Options Pricing," The Journal of Legal Studies, University of Chicago Press, vol. 24(1), pages 139-63, January.
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