Standard Breach Remedies, Quality Thresholds, and Cooperative Investments

When investments are nonverifiable, inducing cooperative investments with simple contracts may not be as difficult as previously thought. Indeed, modeling "expectation damages" close to legal practice, we show that the commonly applied remedy of US contract law induces the first best. Yet, to lower informational requirements of courts, parties may opt for a "specific performance" regime, which grants the breached-against buyer an option to choose "restitution" if the tender's value falls below some (arbitrarily chosen) quality threshold. To implement this regime, no more information needs to be verifiable than is implicitly assumed in Che and Hausch (1999. "Cooperative Investments and the Value of Contracting," 89 American Economic Review 125--47). (JEL K12, L22, J41, C70) The Author 2010. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.