Working Paper: NBER ID: w13960
Authors: Surajeet Chakravarty; W. Bentley Macleod
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 paper 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 vs. Baxendale are efficient solutions to the problem of implementing complex exchange.
Keywords: Contract theory; Legal remedies; Construction contracts; Governance covenants
JEL Codes: D02; K12; L23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| American standard form construction contracts (L74) | efficient mechanisms for implementing building projects (L74) |
| governance covenants (G38) | allocate authority and regulate ex post bargaining power (L49) |
| governance structures (G38) | mitigate risks associated with renegotiation (D86) |
| legal remedies (mistake, unforeseen events) (K41) | facilitate efficient outcomes (L21) |
| contract design + legal frameworks (K12) | optimal performance in complex exchanges (D51) |