This paper considers trading environments in which buyers are privately informed about their valuations and sellers are privately informed about the expected value of outside trading opportunities. Outside opportunities are stochastic, however, and future realized shocks may make bilateral trade between a buyer and a seller inefficient. In this environment, there is a role for using liquidated damage clauses as a screening device in optimal contracts, whether designed by the seller, designed by the buyer or designed by a third-party. In all such design settings, liquidated damages are set below the buyer's valuation. Excessive liquidated damage clauses are never optimal in this trading environment and may be a symptom of another contracting distortion or failure. These findings provide a partial rationalization for why courts may strike down liquidated damage clauses when they are excessive, but not when they are insufficient to compensate the harmed party.

This book examines the main issues arising in economic analysis of contract law with special attention given to the incomplete contracts. It discusses both the main features of contract law as they relate to the problem of economic exchange, and how the relevant legal rules and the institutions can be analysed from an economic perspective. Evaluate the welfare impacts, analyses the effects and the desirability of different breach remedies and examines the optimal incentive structure of party-designed liquidated damages under the different dimensions of informational asymmetry. Overall the book aims to contribute to the legal debate over the adoption of the specific breach remedies when the breach victim’s expectation interest is difficult to assess, and to the debate over courts' reluctance to implement large penalties in the event of breach of contracts.

The Oxford Handbook of Law and Economics applies the theoretical and empirical methods of economics to the study of law. Volume 2 surveys Private and Commercial Law.

What effects do laws have? Do individuals drive more cautiously, clear ice from sidewalks more diligently, and commit fewer crimes because of the threat of legal sanctions? Do corporations pollute less, market safer products, and obey contracts to avoid suit? And given the effects of laws, which are socially best? Such questions about the influence and desirability of laws have been investigated by legal scholars and economists in a new, rigorous, and systematic manner since the 1970s. Their approach, which is called economic, is widely considered to be intellectually compelling and to have revolutionized thinking about the law. In this book Steven Shavell provides an in-depth analysis and synthesis of the economic approach to the building blocks of our legal system, namely, property law, tort law, contract law, and criminal law. He also examines the litigation process as well as welfare economics and morality. Aimed at a broad audience, this book requires neither a legal background nor technical economics or mathematics to understand it. Because of its breadth, analytical clarity, and general accessibility, it is likely to serve as a definitive work in the economic analysis of law.