Abstract
The Coase theorem tells us that monetary damages and specific performance remedies for breach of contract have identical effects when transaction costs are zero. This has become a standard part of the literature on the economics of contract law. This note argues that the traditional view is somewhat misguided, as monetary damages and specific performance remedies are unnecessary in a zero transaction costs world. We go on to show how the presence of transaction costs impact the decisions of contracting parties as between the inclusion of liquidated damages clauses in contracts and resorting to litigation that could result in the application of either monetary damages or specific performance remedies.
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Notes
Since Guido receives the same payout regardless of the legal rule, tension concerning the division of economic surplus will exist only between Richard and Ronald.
On this strict definition of a zero-transaction-costs world, see, in addition to the references cited above, the discussion in Medema and Zerbe (2000).
We recognize that it is a bit odd to allow for the possibility of positive court costs in a world where the costs of negotiation are zero. However, the assumption of an environment in which parties can costlessly negotiate and draw up fully-specified contracts does not negate the ability of courts to charge fees for the filing of lawsuits.
Holdout problems and the like are irrelevant here because of the assumption of zero costs of negotiation.
Of course the parties will be indifferent between liquidated damages and a court-imposed remedy if they are risk neutral and will prefer to forego a liquidated damages clause if they are risk lovers.
References
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DeAngelo, G., Medema, S.G. Those crazy transaction costs: on the irrelevance of the equivalence between monetary damages and specific performance. Eur J Law Econ 37, 269–275 (2014). https://doi.org/10.1007/s10657-011-9285-0
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DOI: https://doi.org/10.1007/s10657-011-9285-0