Ex Ante versus Ex Post Expectation Damages
Indiana State University - Scott College of Business
University of Texas at Austin - School of Law
November 9, 2012
International Review of Law and Economics, Vol. 32, pp. 339-355, 2012
University of Texas Law, Law and Economics Research Paper No. 138
What information should courts utilize when assessing contract damages? Should they award damages that were rationally foreseeable at the ex ante stage (ex ante expected damages)? Or should they award damages at the ex post level, incorporating new information revealed after contracting (ex post actual damages)? In practice courts have varied between the two approaches, awarding damages equal to the lower, or the higher, of the two measures of damages. This article shows that ex ante expectation damages are more efficient than ex post actual damages through a simple model of costly litigation for contract breach, where there are either costs of verifying the breach victim’s ex post damages, or general litigation costs such as attorneys’ fees. Courts should award foreseeable flat damages, rather than seeking ex post accuracy and awarding actual damages, because actual damages lead to distortions in breach incentives once we take parties’ litigation decisions as endogenous. With costly litigation, ex post expectation damages may cause over-performance or under-performance depending on whether the American or the English rule applies and on the size of the litigation cost. We find that regardless of the direction of the distortion, actual damages induce inefficiency. Ex ante damages are more efficient because of the insensitivity of parties’ litigation decisions to their ex post private information under fixed damages. Our results are robust when accounting for renegotiation.
Number of Pages in PDF File: 18
Keywords: of Contract, Asymmetric Information, Expectation Interest, Renegotiation
JEL Classification: K0, K12, D82, D86working papers series
Date posted: March 5, 2010 ; Last revised: November 10, 2012
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