Yotam Kaplan, ‘Rethinking the Paradox of Compensation’

The paradox of compensation suggests that it is impossible to design an optimal contract remedy: while compensation for breach makes promisors breach and perform optimally, it also makes promisees indifferent to the harms of breach, thereby allowing them to over-rely. The current paper proposes a solution to this paradox, using a rule that assures optimal levels of performance without making promisees indifferent to the possibility of breach. Such a rule would allow the promisee to induce promisor breach and require the promisor to disgorge any breach profits to the promisee. This assures optimal performance, as the promisee can order breach and enjoy the full benefits associated with it, as well as optimal levels of promisee reliance, since in case of breach the promisee’s profits do not depend on her level of reliance.

Yotam Kaplan, Rethinking the Paradox of Compensation. Discussion Paper No 60, 08/2014. John M Olin Center for Law, Economics, and Business, Fellows’ Discussion Papers Series.

First posted 2014-09-06 09:13:50

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