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Optimal Contracting With Boundedly Rational Agents

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Author Info
Manfred Königstein (Humboldt-University of Berlin, Institute for Economic Theory III, Berlin, Germany)
Abstract

Principal-agent theory usually assumes that the players are perfectly rational. In contrast, real human decision makers are only boundedly rational. If a firm (principal) wants to design a work contract that maximizes profit, it should consider how workers (agents) will actually react rather than how they should react if they were perfectly rational. In this paper the data of a principal-agent experiment are used to estimate the agents' probability of accepting an offered contract as well as the expected effort choice. Both empirical acceptance and effort behavior reject the assumption of perfectly rationality. Estimation results are used to illustrate the problem of optimal contracting. It turns out that profit maximization calls for offering intermediate incentive contracts rather than high incentive contracts. Furthermore, agents should be offered a considerably higher income than the outside option value.

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Publisher Info
Article provided by Institute of SocioEconomics in its journal Homo Oeconomicus.

Volume (Year): 18 (2001)
Issue (Month): ()
Pages: 211-228
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Handle: RePEc:hom:homoec:v:18:y:2001:p:211-228

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  1. Antonio Cabrales & Gary Charness, 2003. "Optimal Contracts, Adverse Selection & Social Preferences: An Experiment," University of California at Santa Barbara, Economics Working Paper Series 11-03, Department of Economics, UC Santa Barbara. [Downloadable!]
  2. Simon Gaechter & Manfred Koenigstein, 2006. "Design a Contract! A Simple Principal-Agent Problem as a Classroom Experiment," Discussion Papers 2006-04, The Centre for Decision Research and Experimental Economics, School of Economics, University of Nottingham. [Downloadable!]
  3. Antonio Cabrales & Gary Charness & Marie-Claire Villeval, 2006. "Competition, Hidden Information and Efficiency: An Experiment," IZA Discussion Papers 2296, Institute for the Study of Labor (IZA). [Downloadable!]
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