Contracting in the shadow of the law

Surajeet Chakravarty, W. Bentley MacLeod

Research output: Contribution to journalArticlepeer-review

28 Scopus citations

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 article 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 v. Baxendale are efficient solutions to the problem of implementing complex exchange.

Original languageEnglish (US)
Pages (from-to)533-557
Number of pages25
JournalRAND Journal of Economics
Volume40
Issue number3
DOIs
StatePublished - 2009
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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