Contract Remedies and Options Pricing

Abstract

This article examines the choice between money damages and specific performance as the remedy for contract breach by drawing on the theory of options valuation. The ability to breach and pay money damages is analogous to granting the breaching party an option to buy back his performance for a strike price equal to the damages award. The option affects the parties' returns from the contract and the variance of those returns. The parties' ex ante preference for money damages or specific performance should therefore depend, among other things, on their ability to value the option and their attitudes toward risk. The article examines the parties' ability to determine the option value and the effects of that value on their preferences under various assumptions. It concludes that the options analogy helps to explain the common law's choice of money damages as the normal remedy and the most common exceptions.