Timing Problems in Contract Breach Decisions

Alexander J Triantis and George G Triantis

Journal of Law and Economics, 1998, vol. 41, issue 1, 163-207

Abstract: In contracts susceptible to efficient breach, each party has an American option to breach and pay damages rather than perform. She will repudiate early if the expected decrease in damages liability resulting from her partner's mitigation exceeds the expected value of the terminated contract, including the option to breach in the future. We show that each party has the incentive to repudiate earlier than socially optimal because expectation damages compensate the nonrepudiating party only for the loss of the completed exchange and not the value of its lost breach option. This inefficiency is particularly acute in long-term, fixed-price contracts in which the cost of performance to the promisor and the value to the promisee are volatile and uncorrelated. We explore various responses to this problem, including vertical integration, changes in contract remedies (including specific performance), flexible price provisions, and the capital structure of each party. Copyright 1998 by the University of Chicago.

Date: 1998
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:ucp:jlawec:v:41:y:1998:i:1:p:163-207

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