NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Cadillac Contracts and Up-Front Payments: Efficient Investment Under Expectation Damages

Aaron S. Edlin

NBER Working Paper No. 4915
Issued in November 1994
NBER Program(s):   LE

This paper shows that up-front payments can play a crucial role in providing efficient investment incentives when contracts are incomplete. They can eliminate the overinvestment effect identified by Rogerson [1984] and Shavell [1980] when courts use an expectation damage remedy. This method extends to complex contracting situations if parties combine up-front payments with what we call 'Cadillac' contracts (contracts for a very high quality or quantity). This combination provides efficient investment incentives in complex contracting problems when an expectation damage remedy is accompanied by a broad duty to mitigate damages. This indicates that an expectation remedy is well-suited to multidimensional, but one-sided, investment problems, in contrast to specific performance, which Edlin and Reichelstein [1993] showed is well-suited to two-sided, but unidimensional, investment problems.

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Document Object Identifier (DOI): 10.3386/w4915

Published: Edlin, Aaron S. "Cadillac Contracts And Up-Front Payments: Efficient Investment Under Expectation Damages," Journal of Law, Economics and Organization, 1996, v12(1,Apr), 98-118. citation courtesy of

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