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

Journal of Law, Economics, & Organization, 2012, 28(1): 77-102.

U of Texas Law, Law and Econ Research Paper No. 178

26 Pages Posted: 14 Jul 2008 Last revised: 31 Dec 2017

See all articles by Ronen Avraham

Ronen Avraham

Tel Aviv University - Tel Aviv University, Buchmann Faculty of Law; University of Texas at Austin - School of Law

Zhiyong (John) Liu

Indiana State University - Scott College of Business

Date Written: October 1, 2009

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 Classification: K0, K12, D82, D86

Suggested Citation

Avraham, Ronen and Liu, Zhiyong (John), Private Information and the Option to Not Sue: A Re-evaluation of Contract Remedies (October 1, 2009). Journal of Law, Economics, & Organization, 2012, 28(1): 77-102.; U of Texas Law, Law and Econ Research Paper No. 178. Available at SSRN: https://ssrn.com/abstract=1158618 or http://dx.doi.org/10.2139/ssrn.1158618

Ronen Avraham (Contact Author)

Tel Aviv University - Tel Aviv University, Buchmann Faculty of Law ( email )

Tel Aviv
Israel

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 (John) Liu

Indiana State University - Scott College of Business ( email )

Scott College of Business
Indiana State University
Terre Haute, IN 47809
United States

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