Unbundling Efficient Breach: An Experiment

• Author: Francesco Parisi,Ariel Porat,Maria Bigoni,Stefania Bortolotti
• Date: 01 September 2017
• Published date: 01 September 2017
• DOI: http://doi.org/10.1111/jels.12154

Unbundling Efficient Breach:

An Experiment

Maria Bigoni, Stefania Bortolotti, Francesco Parisi, and Ariel Porat*

Current law and economics scholarship analyzes efficient breach cases monolithically. The

standard analysis holds that breach is efficient when performance of a contract generates a

negative total surplus for the parties. However, by simplistically grouping efficient breach

cases as of a single kind, the prior literature overlooks that gain-seeking breaches might be

different from loss-avoiding breaches. To capture these different motives, we designed a

novel game called the Contract-Breach Game where we exogenously varied the reasons for

the breach---pursuing a gain or avoiding a loss---under a specific performance remedy.

Results from an incentivized laboratory experiment indicate that the motives behind the

breach induce sizable differences in behavior; subjects are less willing to renegotiate when

facing gain-seeking than loss-avoiding breaches, and the compensation premium obtained

by the promisee is higher. Our analysis suggests that inequality aversion is an important

driver of our results; indeed, inequality-averse subjects accept low offers more often in cases

of loss-avoiding breaches than gain-seeking breaches. These results give us insight into the

preferences and expectations of ordinary people in a case of a breach.

[T]he essential purpose of a contract between commercial men is actual perfor-

mance and they do not bargain merely for a promise, or for a promise plus the

right to win a lawsuit. (UCC, Section 2–609, Comment 1)

I. Introduction

On the question of efficient breach, there exists a subtle tension between the economic

and the moral viewpoints. Both perspectives consider the failure to keep a promise

*Address correspondence to Ariel Porat,Faculty of Law, Tel Aviv University,Ramat Aviv, Tel Aviv-69978, Israel;email:

porata@post.tau.ac.il. Bigoni is Associate Professor, Department of Economics, University of Bologna; Bortolotti is

Research Fellow, Faculty of Management, Economics and Social Sciences, University of Cologne; Parisi is the

Oppenheimer Wolff and Donnelly Professor of Law at the University of Minnesota, Law School and a Professor

of Economics at the University of Bologna, Department of Economics; Porat is the Alain Poher Professor of Law

at Tel Aviv University and Fischel-Neil Distinguished Visiting Professor of Law at the University of Chicago.

The authors thank Daniel Pi for his valuable research assistance, Sergio Mittlaender, Ben Depoorter, two

anonymous referees, and participants at the 2016 European Association of Law and Economics, Bologna, Italy;

2015 Workshop on Institutions & Organizations at UPF, Barcelona, Spain; and 2013 Workshop on Behavioural

Economics, Trento, Italy.

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Journal of Empirical Legal Studies

Volume 14, Issue 3, 527–547, September 2017

excusable in at least some subset of cases when the net social benefit of breach is suffi-

ciently large (Warkol 1998:321). Yet they do not always agree on the boundary conditions

when such breaches may be permitted. Assuming Kaldor-Hicks wealth maximization, the

standard economic analysis contends that if the promisor gains more than the promisee

loses from a breach, then a damages rule (allowing nonperformance with compensation)

will be efficient. Moreover, to the extent that expectation damages are perfectly compensa-

tory, and the promisee is thereby fully compensated, such a breach would be Pareto effi-

cient, leaving neither party in a worse position than if the promisor had in fact performed.

In contrast, deontological philosophers of contract law take the moral duty to keep one’s

promises as a foundational principle of contracts that cannot be brushed aside by cost-

benefit analyses (Sidhu 2006; Mather 1999; Fried 1981; Shiffrin 2009, 2012).

Judicial and lay intuitions seem ambivalent with respect to the notion of efficient

breach (Warkol 1998; Baron & Wilkinson-Ryan 2009; Zamir & Medina 2010). In general,

the intuitions of laymen seem to track consequentialist (economic) reasoning in cases

of loss-avoiding breach, while being deontological (moralist) in cases of gain-seeking

breach. Consider, for instance, two firms renting a restaurant for their annual event. In

the first case, the restaurant’s owners try to cancel the reservation due to the sudden

demise of the chef and ask the firm to breach the contract, offering some compensa-

tion, as replacing the chef in haste would be too costly. In the second case, the restau-

rant’s owners want to breach the contract because they received a better offer from

another group willing to rent the space on the same date. We believe that one might

well be more inclined to forego performance and ask for a lower compensation in the

first (loss-avoiding breach) rather than in the second example (gain-seeking breach).

This thought experiment suggests that the distinction between loss-avoiding and gain-

seeking breach may be analytically important.

In line with our intuition, survey-based studies (Baron & Wilkinson-Ryan, 2009)

suggest that lay intuitions about the excusableness of nonperformance are surprisingly

nuanced. Survey participants were tolerant of breach in cases where the promisor

sought to pay damages in lieu of performance to mitigate unanticipated costs (loss-

avoiding breach). Yet they were unwilling to excuse performance when the promisor

breached to pursue a better deal (gain-seeking breach).

Existing empirical evidence on these issues relies exclusively on anecdotal evi-

dence from court cases, and from nonincentivized surveys. Unfortunately, data about

actually occurring breaches are scarce. Moreover, comparing real-world loss-avoiding

and gain-seeking breaches is difficult, as many important variables—interested parties,

amount of surplus generated by the contract, available information, and so forth—may

vary from one case to the other, hence making it difficult to draw any inference. Eco-

nomic reasons, such as allocative efficiency, productive efficiency, restrained incentives,

information-forcing effects, and competitive effects could also drive any observed differ-

ence (see Bigoni et al. 2016). In this article, we adopt a novel approach to the problem,

and test whether the motives behind a breach are behaviorally relevant by means of a

controlled laboratory experiment. We utilize an incentivized economic experiment

granting tight control over the relevant parameters and allowing to exogenously

528 Bigoni et al.