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Sunday, December 7, 2008

Wilkinson-Ryan on the Behavioral Economics of Efficient Breach and Liquidated Damages

Tesswilkinsonryan_2Tess Wilkinson-Ryan, Sharswood Fellow in Law and Psychology at the University of Pennsylvania School of Law, recently posted Do Liquidated Damages Clauses Encourage Efficient Breach?, in which she (1) reports the methodology and results of a series of experiments designed to elicit participants' hypothetical likelihood to breach an existing contract either because what they thought was a winning contract now looks to be a losing one or because a more lucrative, but mutually exclusive, opportunity has come along, (2) introduces a liquidated damages provision to the hypothetical contract and reports how its presence or absence appeared to affect participants' responses, and then (3) attempts to draw from her experimental results broad conclusions about the cognitive processes of her sample groups and the implications her results have for efficient breach theory.  Here's an excerpt from the abstract:

Economic theorists predict that parties will breach a contract when it is possible to pay expectation damages to the promisee and still make a net profit.  The moral obligations entailed by a promise, however, implicate unusually robust moral intuitions which in turn may deter parties from breaching even when there is an economic incentive to do so.  In this paper I use experimental methods to investigate the role of moral norms in parties' propensity to capitalize on efficient breach opportunities....  In the last experiment, subjects were asked to think about the effect of a liquidated damages clause on their intuitions. The most important result from this study is that subjects required less money to breach contracts with liquidated damages than otherwise identical contracts.

I have some concerns, which I am happy to discuss with the author, about her methodology (or at least her methodological explanation), the way she characterizes efficient breach theory, and the robustness of a couple of her conclusions.  Those concerns aside, this is an interesting working paper that is, at the very least, a substantial first step toward an interesting article.

[Keith A. Rowley]

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