Authority and Contract∗

Previous analysis of contract damages supposes that the courts take a passive role in the determination of breach. However, a review of the case law for construction contracts reveals that the courts often inquire in to the scope of individual authority, and use this information to determine breach. This paper integrates such allocation of authority in a two period contract model with bilateral investment and asymmetric information. It is shown that there is a contract implementing the first best that has many of the features of observed construction contracts. Moreover, if procurement for a complex project is based upon choosing the bidder with the lowest price, then cost overruns can occur with certainty. We would like to thank George Lefco and Kenneth Williams of Cox, Castle and Nicholson LLP for helpful discussions regarding construction law. Candice Jackson and Alexey Ravichev provided able research assistance for this project. We are grateful for the support of the National Science Foundation for financial support under grant SES 0095606, and the Center for Law, Economics and Organization at USC. Corresponding author Department of Economics, University of Southern California, Los Angeles, CA 90089-0253.