Thomas P. Lyon, Erb Faculty Member was published in the Journal of Regulatory Economics, 22(2): 107-132. Thomas P. Lyon and Haizhou Huang (2002)
We present a model of the regulatory “contract” that focuses on the mutual investment of buyer and seller and recognizes the cost of contractual renegotiation and the importance of breach remedies when contracts are incomplete. We model renegotiation as a litigation game played before a quasi-judicial administrative court. We find that the standard contractual remedy of expectations damages cannot implement first-best levels of investment for both buyer and seller. If the seller fully recovers its sunk investment upon buyer breach, however, then first-best levels of investment by both buyer and seller can be supported provided litigation costs are small enough.