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Contracting in the Shadow of the Law

Surajeet Chakravarty and W. Bentley Macleod

No 13960, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Economic models of contract typically assume that courts enforce obligations based on verifiable events (corresponding to the legal rule of specific performance). As a matter of law, this is not the case. This leaves open the question of optimal contract design given the available remedies used by the courts. This paper shows that American standard form construction contracts can be viewed as an efficient mechanism for implementing building projects given existing legal rules. It is shown that a central feature of these contracts is the inclusion of governance covenants that shape the scope of authority, and regulate the ex post bargaining power of parties. Our model also implies that the legal remedies of mistake, impossibility and the doctrine limiting damages for unforeseen events developed in the case of Hadley vs. Baxendale are efficient solutions to the problem of implementing complex exchange.

JEL-codes: D02 K12 L23 (search for similar items in EconPapers)
Date: 2008-04
New Economics Papers: this item is included in nep-cta, nep-law and nep-reg
Note: LE LS
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Published as Surajeet Chakravarty & W. Bentley MacLeod, 2009. "Contracting in the shadow of the law," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 533-557.

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