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Private Information and the Option to Not Sue: A Re-evaluation of Contract Remedies

Ronen Avraham
University of Texas at Austin - School of Law

Zhiyong Liu
Georgia State University - Department of Risk Management & Insurance


October 6, 2009

Northwestern Law & Econ Research Paper No. 05-02

Abstract:     
In this paper we study contracts with two-sided incomplete information. Prior literature on contract remedies does not formally account for the non-breaching party’s option to not sue for damages upon breach, when her expected payoff from suing is negative, given the contractual terms and her private information about her post breach loss. With this option incorporated into the analysis, we show that: First, courts should commit to awarding fixed damages, because awarding flexible damages based on ex post information will distort the incentives to breach. This result is not driven by the information forcing effect of basing damages on ex ante expectations, à la Hadley vs. Baxendale. Second, the option of acquiescing to the breach expands the breach set under specific performance, which can be more efficient than other remedies. Third, the efficiency advantage of ex ante expectation damages over ex post actual damages is further enhanced when we account for the possibility of renegotiation. The main results are robust when we account for verification cost of plaintiff’s damages and for parties' litigation cost.

Keywords: Breach of Contract, Damages Measures, Asymmetric Information, Litigation, Renegotiation

JEL Classifications: K0, K12, D82, D86

Working Paper Series

Date posted: July 14, 2008 ; Last revised: February 09, 2010

Suggested Citation

Avraham, Ronen and Liu, Zhiyong, Private Information and the Option to Not Sue: A Re-evaluation of Contract Remedies (October 6, 2009). Northwestern Law & Econ Research Paper No. 05-02. Available at SSRN: http://ssrn.com/abstract=1158618


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Contact Information

Ronen Avraham (Contact Author)
University of Texas at Austin - School of Law ( email )
727 East Dean Keeton Street
Austin, TX 78705
United States
(512) 232-1357 (Phone)
HOME PAGE: http://www.utexas.edu/law/faculty/profile.php?id=ra22397

Zhiyong Liu
Georgia State University - Department of Risk Management & Insurance ( email )
P.O. Box 4036
Atlanta, GA 30302-4036
United States
Feedback to SSRN (Beta)


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