Breach Remedies Inducing Hybrid Investments ∗

We show that parties in bilateral trade can rely on the default breach rem-edy of common law, ‘expectation damages’, to simultaneously induce first-best relationship-specific investments of both the selfish and the cooperative kind. Specif-ically, this can be achieved by writing a so called Cadillac contract, i.e., a contract which sets the quality required under the contract sufficiently high. In contrast, the result by Che and Chung (1999) that ‘reliance damages ’ induce the first best in a setting of purely cooperative investments cannot be generalized to the hybrid case. Moreover, the standard result that ‘expectation damages ’ induce ex-post efficient breach no longer generally holds in the presence of cooperative investments