Cadillac Contracts and Up-Front Payments: Efficient Investment Under Expectation Damages

36 Pages Posted: 5 Aug 2000

See all articles by Aaron S. Edlin

Aaron S. Edlin

University of California at Berkeley; National Bureau of Economic Research (NBER)

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Date Written: November 1994

Abstract

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 [1984] and Shavell [1980] 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 [1993] showed is well-suited to two-sided, but unidimensional, investment problems.

Suggested Citation

Edlin, Aaron S., Cadillac Contracts and Up-Front Payments: Efficient Investment Under Expectation Damages (November 1994). NBER Working Paper No. w4915. Available at SSRN: https://ssrn.com/abstract=238137

Aaron S. Edlin (Contact Author)

University of California at Berkeley ( email )

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