An experimental comparison of reliance levels under alternative breach remedies

Breach remedies serve an important role in protecting relationship-specific invest ments. The theoretical literature predicts that some commonly used types of breach remedies may protect too well, in the sense that they induce overinvestment. The driving forces behind this result are the complete insurance against potential separation that breach remedies may provide, and the possibility to prevent breach by increasing the damage payment due through the investment made. In this paper we report on an experiment designed to address whether these two motives show up in practice. Three breach remedies are studied: (i) liquidated damages, (ii) expectation damages and (iii) reliance damages. In line with theoretical predictions we find that overinvestment does not occur under liquidated damages. In case of expectation damages the full insurance motive indeed appears to be operative. In case of reliance damages both motives are at work, as is predicted.