Should courts continue to refuse to enforce liquidated-damages clauses in contracts?
Many economists have answered no — on the ground that such a posture prevents parties from entering into mutually beneficial deals. Eric Talley disagrees, contending that a refusal to enforce such clauses will advance economic efficiency: I argue that the current judicial treatment of stipulated damages may facilitate Coasean transactions by minimizing contract renegotiation costs. Central to this thesis is the observation that contract renegotiation entails a bilateral monopoly market structure, in which neither party competes with an outside “market” to set price. Furthermore, each party usually possesses some private information about the state of the world (for example, only the promisor knows her best alternative offer, and only the promisee knows his actual damages). This combination of a thin market and private information can impose substantial costs due to strategic behavior, which in turn can frustrate the negotiation process even in the presence of potential gains from trad
