Consider a contractual setting in which the technology of the relationship between a worker (row player) and firm (column player) is given by the following underlying game:
Provide a Bonus Do Not Provide a Bonus
Work Hard 4,7 -4,8
Shirk 2,-2 0,0
Suppose the players contract in a setting of court-imposed breach remedies. The players can write a contract specifying the strategy profile they intend to play; the court observes their behavior in the underlying game and, if one or both of them cheated, imposes a breach transfer. The players wish to support the outcome (Work Hard, Provide a Bonus).
a. Write the matrix representing the induced game under the assumption that the court imposes expectation damages. Can a contract specifying (Work Hard, Provide a Bonus) be enforced? Explain.
Suppose that litigation is costly. When a contract is breached, each player has to pay a court fee of "c" (c >= 0) in addition to the expectation damages imposed by the court. Assume that in case the court observes the outcome (Shirk, Do not Provide a Bonus), it does not impose any court fee.
b. What is the induced game in this case? Under what condition on "c" can a contract specifying (Work Hard, Provide a Bonus) be enforced with expectation damages and court costs?
c. How does your answer to part b. change if the court forces the party that deviates to pay all court costs?