Regulating Damage Clauses in (Labor) Contracts

31 Pages Posted: 27 Oct 2006

See all articles by Gerd Muehlheusser

Gerd Muehlheusser

University of Hamburg; IZA Institute of Labor Economics

Date Written: October 2006


We analyze the role of damage clauses in labor contracts using a model in which a worker may want to terminate his current employment relationship and work for another firm. We show that the initial parties to a contract have an incentive to stipulate excessive damage clauses, which leads to ex post inefficiencies. This result is due to rent seeking motives a) between the contracting parties vis-à-vis third parties and b) among the contracting parties themselves. We then show that, by imposing an upper bound on the amount of enforceable damages, a regulator can induce a Pareto improvement; in some cases even the first best can be achieved.

Keywords: damage clauses, penalty doctrine, breach of contract, asymmetric information, labor contracts

JEL Classification: K12, K31, M12

Suggested Citation

Muehlheusser, Gerd, Regulating Damage Clauses in (Labor) Contracts (October 2006). Institute for the Study of Labor Discussion Paper No. 2367. Available at SSRN:

Gerd Muehlheusser (Contact Author)

University of Hamburg ( email )

Von Melle Park 5
Hamburg, 20146

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072

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