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Cadillac Contracts and Up-Front Payments: Efficient Investment Under Expectation Damages

Listed author(s):
  • Aaron S. Edlin

This paper shows that up-front payments can play a crucial role in providing efficient investment incentives when contracts are incomplete. They can eliminate the overinvestment effect identified by Rogerson [1984] and Shavell [1980] when courts use an expectation damage remedy. This method extends to complex contracting situations if parties combine up-front payments with what we call 'Cadillac' contracts (contracts for a very high quality or quantity). This combination provides efficient investment incentives in complex contracting problems when an expectation damage remedy is accompanied by a broad duty to mitigate damages. This indicates that an expectation remedy is well-suited to multidimensional, but one-sided, investment problems, in contrast to specific performance, which Edlin and Reichelstein [1993] showed is well-suited to two-sided, but unidimensional, investment problems.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4915.

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Date of creation: Nov 1994
Publication status: published as Edlin, Aaron S. "Cadillac Contracts And Up-Front Payments: Efficient Investment Under Expectation Damages," Journal of Law, Economics and Organization, 1996, v12(1,Apr), 98-118.
Handle: RePEc:nbr:nberwo:4915
Note: LE
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  1. Keith Head & John C. Ries & Deborah L. Swenson, 1994. "The Attraction of Foreign Manufacturing Investments: Investment Promotion and Agglomeration Economies," NBER Working Papers 4878, National Bureau of Economic Research, Inc.
  2. David Cutler, 1994. "Market Failure in Small Group Health Insurance," NBER Working Papers 4879, National Bureau of Economic Research, Inc.
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