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Regulating Damage Clauses in (Labor) Contracts

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  • Muehlheusser, Gerd

    () (University of Hamburg)

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.

Suggested Citation

  • Muehlheusser, Gerd, 2006. "Regulating Damage Clauses in (Labor) Contracts," IZA Discussion Papers 2367, Institute for the Study of Labor (IZA).
  • Handle: RePEc:iza:izadps:dp2367
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    References listed on IDEAS

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    1. 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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    4. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
    5. Chung, Tai-Yeong, 1992. "On the Social Optimality of Liquidated Damage Clauses: An Economic Analysis," Journal of Law, Economics, and Organization, Oxford University Press, vol. 8(2), pages 280-305, April.
    6. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 473-494.
    7. Steven Shavell, 1980. "Damage Measures for Breach of Contract," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 466-490, Autumn.
    8. 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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    11. 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 105-138, January.
    12. 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.
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    More about this item

    Keywords

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

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • K31 - Law and Economics - - Other Substantive Areas of Law - - - Labor Law
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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