UCLA

We show that parties in bilateral trade can rely on the default common law breach remedy of ‘expectation damages’ to simultaneously induce first-best relationship-specific investments of both the selfish and the cooperative kind. This can be achieved by writing a contract that specifies a sufficiently high quality level. In contrast, the result by Che and Chung (1999) that ‘reliance damages’ induce the first best in a setting of purely cooperative investments, does not generalize to the hybrid case.