Efficient Contracting with Reliance and a Damage Measure

This article reexamines the problem of breach of contract studied by Shavell (1980, 1984) and Rogerson (1984) by considering explicitly the incentive problems that arise from asymmetric information and transaction-specific investment. We derive the optimal contract, which consists of variable price and damage payment schedules, each of which is set before any private information is observed. We show that the optimal contract attains full classical efficiency.