Damage measures and incentives to perform

When contracts are completely specified, a high damage measure would be best, in order to give a strong motivation to obey the contract—but only if it is truly completely specified. Then it would be in both parties interest because they could rely on the exact contract they wrote being obeyed.

After all, if the contract is truly complete, then there is no chance of onerous performance because that eventuality would have been deal with by contract. So performance is always guaranteed and there is no reason to breach.

When contracts are incomplete, too-high damages may lead to undesirable performance. Moderate damages are better, since that will lead to breach when performance becomes too difficult or excessive. Thus, in certain circumstances, parties will simply receive expectation damages when it makes sense.

Thus, moderate damages allow for breach when performance would be expensive, and induce performance when it would not be expensive. This leads to performance closest to those under mutually beneficial completely specified contracts. In other words, moderate damage measures serve as substitutes for more complete contracts.

There is a qualification that comes in when contractual duties are purely financial, as damage measures cannot completely substitute for more completely specified contracts.

Steven Shavell, Foundations of Economic Analysis of Law, pp. 305-309 (2004).
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