Optimal Remedies for Bilateral Contracts

In several contract situations, parties exchange promises of future performance, creating reciprocal obligations. In this paper, we extend the standard models of contract remedies to consider the incentives created by contracts where both parties provide only executory consideration and where the parties’ obligations are yet to be performed. We show that the legal remedies that govern these contracts provide valuable enforcement mechanisms that are not available when parties enter into a contract in which they exchange a promise for an actual performance. We show that when the values of the parties’ performances are interdependent, contracts with executory consideration create effort incentives that are superior to the incentives of contracts with executed consideration. In contracts with independent values, contracts with executory consideration also offer a valuable instrument to correct enforcement imperfections. Such imperfections include imperfect compensation and litigation costs.