Breach remedies inducing hybrid investments

Abstract

We show that parties in bilateral trade can rely on the default common law breach remedy of ‘expectation damages’ to simultaneously induce first-best relationship-specific investments of both the selfish and the cooperative kind. This can be achieved by writing a contract that specifies a sufficiently high quality level. In contrast, the result by Che and Chung (1999) that ‘reliance damages’ induce the first best in a setting of purely cooperative investments, does not generalize to the hybrid case.We also show that if the quality specified in the contract is too low, ‘expectation damages’ do not necessarily induce the ex-post efficient trade decision in the presence of cooperative investments.