Introduction

Regulatory contracts, like any other contractual relationships, suffer in developing countries from a severe lack of enforcement. Good laws and rules are rather straightforward to import from the developed world. A good set of lawyers can transfer this institutional knowledge quite easily (if not cheaply). It is much more difficult to enforce them, because of the lack of financial and technical resources, because of the corruption of enforcement institutions, and because of the weak bargaining power of regulators.

The vital role of enforcement for laws, rules, and contracts was first stressed by the Chicago School (Becker, 1968; Stigler, 1970; Becker and Stigler, 1974). They modeled economic agents as performing a cost–benefit analysis when breaching the law and they reflected on the role of punishments and their limitations due to corruption and limited liability.

In the law and economics literature (Posner, 1972; Polinsky, 1983), a lot of work has been done on breach of contracts and on the types of remedies which can be offered by the law However, the emphasis is not on how to react to renegations of contracts in fully anticipated states of nature, but rather on how laws can deal simply with circumstances arising from unexpected states of nature.