Cadillac Contracts and Up-Front Payments: Efficient Investment Under Expectation Damages
36 Pages Posted: 5 Aug 2000
Date Written: November 1994
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  and Shavell  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  showed is well-suited to two-sided, but unidimensional, investment problems.
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