Published in: The RAND Journal of Economics 34 (2). (2003). 205-222. (with Randolph Sloof and Hessel Oosterbeek and Joep Sonnemans)
Breach remedies serve an important role in protecting relationship-specific investments. Theory predicts that some common remedies protect too well and induce overinvestment, either though complete insurance against potential separation or the possibility that breach is prevented byrnincreasing the damage payment due through the investment made. In this article we report on an experiment designed to address whether these two motives show up in practice. In line with theoretical predictions, we find that overinvestment does not occur under liquidated damages. In the case of expectation damages, the full-insurance motive indeed appears to be operative. In the case of reliance damages, both motives are at work, as predicted.