Contract Damages and Investment Dynamics

The present article provides an economic analysis to examine how contract damages affects both breach and investment decisions over time. Unlike the standard static model, this article studies a model in which, upon signing a contract, a seller invests over two periods, and a buyer may breach at the end of each period. The dynamic structure of the model allows us to investigate investment dynamics under alternative contract damages. First, under expectation damages, the seller has an incentive to invest only in the first period (front-loading of investment). Second, under reliance damages, a similar front-loading of investment occurs, and the degree of front-loading is excessive relative to the expectation damages. Third, under restitution damages, the seller has an incentive to invest only in the second period. We also examine efficiency properties of new hybrid measures of damages in which damages depend on the timing of breach.Contract Damages, Investment Dynamics