Regulating Damage Clauses in (Labor) Contracts

Gerd Muehlheusser ()
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Gerd Muehlheusser: University of Hamburg

No 2367, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: 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: asymmetric information; breach of contract; penalty doctrine; damage clauses; labor contracts (search for similar items in EconPapers)
JEL-codes: K12 K31 M12 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2006-10
New Economics Papers: this item is included in nep-law and nep-reg
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Published - published in: Journal of Institutional and Theoretical Economics, 2007, 163 (4), 531-551

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