On the Design of Contracts and Remedies for Breach
NBER Working Paper No. 727
The implications of uncertainty for the design of contracts and of remedies for their breach are studied. After characterizing complete contingent contracts, incomplete contracts are examined. Specifically, in view of difficulties in making contingent provisions (costs of enumeration and of bargaining; verification of occurrence of events), it is shown for which contingencies provisions are made. Then, in the major part of the paper, two important implicit substitute for contingent terms are analyzed. The first is provided by remedies for breach of contract; for when a party must pay damages for breach, he will be induced to fulfill his obligations in approximately those contingencies which would have been agreed upon under the terms of a detailed contract. The second substitute for contingent terms lies in the opportunity for renegotiation in light of circumstances, since renegotiation will occur in more or less those contingencies where the contract terms would have differed under a more detailed agreement.
Published: Shavell, Steven. "On the Design of Contracts and Remedies for Breach." Quarterly Journal of Economics, Vol. 97, (February 1984), pp. 121-148.