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

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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.

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.

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