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The moral-hazard effect of liquidated damages : an experiment on contract remedies

Sven Höppner (UGent) , Lars Freund and Ben Depoorter (UGent)
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Abstract
Recent evidence suggests that liquidated-damages clauses provide efficiency advantages by crowding out contracting parties’ deontological concerns about efficient breach. In this paper we highlight an important downside to damage stipulations by parties. Based on findings obtained in a controlled laboratory experiment, we suggest that express damage stipulations trigger negative reciprocity and moral hazard, reducing performance by contract promisors. Such negative effects are absent when damages are exogenously imposed. Moreover, our results indicate that when stipulating damages, contract parties attain less cooperative surplus than when they are subject to an exogenously imposed remedy. Principals, not agents, bear this loss. (JEL: K12, D63, D86, L14, C25, C70, C91)
Keywords
ULTIMATUM GAMES, BREACH, FAIRNESS, RECIPROCITY, MODEL, RENEGOTIATION, INFORMATION, INVESTMENT, EFFICIENCY, PENALTIES

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Chicago
Höppner, Sven, Lars Freund, and Ben Depoorter. 2017. “The Moral-hazard Effect of Liquidated Damages : an Experiment on Contract Remedies.” Journal of Institutional and Theoretical Economics-zeitschrift Fur Die Gesamte Staatswissenschaft 173 (1): 84–105.
APA
Höppner, S., Freund, L., & Depoorter, B. (2017). The moral-hazard effect of liquidated damages : an experiment on contract remedies. JOURNAL OF INSTITUTIONAL AND THEORETICAL ECONOMICS-ZEITSCHRIFT FUR DIE GESAMTE STAATSWISSENSCHAFT, 173(1), 84–105. Presented at the 34th International Seminar on the New Institutional Economics .
Vancouver
1.
Höppner S, Freund L, Depoorter B. The moral-hazard effect of liquidated damages : an experiment on contract remedies. JOURNAL OF INSTITUTIONAL AND THEORETICAL ECONOMICS-ZEITSCHRIFT FUR DIE GESAMTE STAATSWISSENSCHAFT. 2017;173(1):84–105.
MLA
Höppner, Sven, Lars Freund, and Ben Depoorter. “The Moral-hazard Effect of Liquidated Damages : an Experiment on Contract Remedies.” JOURNAL OF INSTITUTIONAL AND THEORETICAL ECONOMICS-ZEITSCHRIFT FUR DIE GESAMTE STAATSWISSENSCHAFT 173.1 (2017): 84–105. Print.
@article{8506627,
  abstract     = {Recent evidence suggests that liquidated-damages clauses provide efficiency advantages by crowding out contracting parties’ deontological concerns about efficient breach. In this paper we highlight an important downside to damage stipulations by parties. Based on findings obtained in a controlled laboratory experiment, we suggest that express damage stipulations trigger negative reciprocity and moral hazard, reducing performance by contract promisors. Such negative effects are absent when damages are exogenously imposed. Moreover, our results indicate that when stipulating damages, contract parties attain less cooperative surplus than when they are subject to an exogenously imposed remedy. Principals, not agents, bear this loss. (JEL: K12, D63, D86, L14, C25, C70, C91)},
  author       = {Höppner, Sven and Freund, Lars and Depoorter, Ben},
  issn         = {0932-4569},
  journal      = {JOURNAL OF INSTITUTIONAL AND THEORETICAL ECONOMICS-ZEITSCHRIFT FUR DIE GESAMTE STAATSWISSENSCHAFT},
  keywords     = {ULTIMATUM GAMES,BREACH,FAIRNESS,RECIPROCITY,MODEL,RENEGOTIATION,INFORMATION,INVESTMENT,EFFICIENCY,PENALTIES},
  language     = {eng},
  location     = {Sibiu, ROMANIA},
  number       = {1},
  pages        = {84--105},
  title        = {The moral-hazard effect of liquidated damages : an experiment on contract remedies},
  url          = {http://dx.doi.org/10.1628/093245616X14785139251341},
  volume       = {173},
  year         = {2017},
}

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