Contracting in the Shadow of the Law

41 Pages Posted: 23 Apr 2008 Last revised: 25 Aug 2010

See all articles by Surajeet Chakravarty

Surajeet Chakravarty

University of Exeter Business School

W. Bentley MacLeod

Columbia University - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Date Written: April 2008

Abstract

Economic models of contract typically assume that courts enforce obligations based on verifiable events (corresponding to the legal rule of specific performance). As a matter of law, this is not the case. This leaves open the question of optimal contract design given the available remedies used by the courts. This paper shows that American standard form construction contracts can be viewed as an efficient mechanism for implementing building projects given existing legal rules. It is shown that a central feature of these contracts is the inclusion of governance covenants that shape the scope of authority, and regulate the ex post bargaining power of parties. Our model also implies that the legal remedies of mistake, impossibility and the doctrine limiting damages for unforeseen events developed in the case of Hadley vs. Baxendale are efficient solutions to the problem of implementing complex exchange.

Suggested Citation

Chakravarty, Surajeet and MacLeod, William Bentley, Contracting in the Shadow of the Law (April 2008). NBER Working Paper No. w13960. Available at SSRN: https://ssrn.com/abstract=1122748

Surajeet Chakravarty (Contact Author)

University of Exeter Business School ( email )

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William Bentley MacLeod

Columbia University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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IZA Institute of Labor Economics ( email )

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