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Self Selection and market power in risk sharing contracts

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  • Prasad, Kislaya
  • Salmon, Timothy C.

Abstract

Although the theory of optimal contracts and the principal agent model are now well established in the literature, empirical support for this theory has been mixed at best. We use economic experiments to test contract theory and assess the empirical relevance of two possible confounding factors that may explain why the theory has not received stronger empirical support. First, parameters of interest may be biased if agents self-select into projects with differing risk profiles based on risk preferences. Second, differing levels of market power on either side of the market could shift contract terms in ways contrary to theoretical predictions. In general, we find support for classical contract theory augmented to accommodate market power and self-selection based on risk preferences. We also find evidence for a third confound in the form of the characteristics of agents not party to the transaction affecting the terms of the contract.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

Volume (Year): 90 (2013)
Issue (Month): C ()
Pages: 71-86

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Handle: RePEc:eee:jeborg:v:90:y:2013:i:c:p:71-86

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Web page: http://www.elsevier.com/locate/jebo

Related research

Keywords: Incentive contracts; Principal–agent model; Self-selection; Market power; Experiments;

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Cited by:
  1. Kerri Brick & Martine Visser & Justine Burns, 2011. "Risk Aversion: Experimental Evidence from South African Fishing Communities," Working Papers 227, Economic Research Southern Africa.
  2. Sarah Jacobson & Ragan Petrie, 2009. "Learning from mistakes: What do inconsistent choices over risk tell us?," Journal of Risk and Uncertainty, Springer, vol. 38(2), pages 143-158, April.

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