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“Optimal Contracts with Team Production and Hidden Information: An Experimentâ€

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  • Cabrales, Antonio
  • Charness, Gary

Abstract

It is standard in agency theory to search for incentive-compatible mechanisms on the assumption that people care only about their own material wealth. Yet it may be useful to consider social preferences in mechanism design and contract theory. We devise an experiment to explore optimal contracts in an adverse-selection context. A principal offers one of three possible contract menus to a team of two agents of unknown types. We observe numerous rejections of the more lopsided menus, and approach an equilibrium where one of the more equitable menus (which one depends on the reservation payoffs) is proposed and agents accept a contract, selecting actions according to their types. We estimate the Fehr and Schmidt (1999) and Charness and Rabin (2002) models of social preferences with our data, and calculate ex post optimal social-preference contracts. In both cases, the principal could substantially enhance his profitability if he could offer the derived optimal contract menu. We also find evidence that an agent is substantially more likely to reject a contract menu if her teammate rejected a contract menu in the previous period, suggesting that agents may be learning social norms.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt29v1b0pg.

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Date of creation: 01 Mar 2008
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Handle: RePEc:cdl:ucsbec:qt29v1b0pg

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Keywords: Adverse selection; Experiment; Optimal contract; Social preference;

References

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  1. Gary Charness & Matthew Rabin, 2002. "Understanding Social Preferences With Simple Tests," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(3), pages 817-869, August.
  2. Keser, Claudia & Willinger, Marc, 2000. "Principals' principles when agents' actions are hidden," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 18(1), pages 163-185, January.
  3. Gary Charness & Martin Dufwenberg, 2004. "Promises and Partnership," Levine's Bibliography 122247000000000001, UCLA Department of Economics.
  4. Bull, Clive & Schotter, Andrew & Weigelt, Keith, 1985. "Tournaments and Piece Rates: An Experimental Study," Working Papers, C.V. Starr Center for Applied Economics, New York University 85-21, C.V. Starr Center for Applied Economics, New York University.
  5. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262061937, December.
  6. Charness, Gary & Corominas-Bosch, Margarida & Frechette, Guillaume R., 2007. "Bargaining and network structure: An experiment," Journal of Economic Theory, Elsevier, Elsevier, vol. 136(1), pages 28-65, September.
  7. Dufwenberg, Martin & Lundholm, Michael, 2001. "Social Norms and Moral Hazard," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 111(473), pages 506-25, July.
  8. Ananish Chaudhuri, 1997. "The Ratchet Principle in a Principal Agent Game with Unknown Costs: An Experimental Analysis," Departmental Working Papers, Rutgers University, Department of Economics 199608, Rutgers University, Department of Economics.
  9. Werner Güth & Manfred Königstein & Judit Kovács & Enikõ Zala-Mezõ, 2001. "Fairness Within Firms: The Case Of One Principal And Multiple Agents," Schmalenbach Business Review (sbr), LMU Munich School of Management, LMU Munich School of Management, vol. 53(2), pages 82-101, April.
  10. Guth, Werner & Schmittberger, Rolf & Schwarze, Bernd, 1982. "An experimental analysis of ultimatum bargaining," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 3(4), pages 367-388, December.
  11. Nalbantian, Haig R & Schotter, Andrew, 1997. "Productivity under Group Incentives: An Experimental Study," American Economic Review, American Economic Association, American Economic Association, vol. 87(3), pages 314-41, June.
  12. Bentley MacLeod, 2001. "Optimal Contracting with Subjective Evaluation," Theory workshop papers, UCLA Department of Economics 357966000000000036, UCLA Department of Economics.
  13. Werner Güth & Wolfgang Klose & Manfred Königstein & Joachim Schwalbach, 1998. "An experimental study of a dynamic principal-agent relationship," Managerial and Decision Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 19(4-5), pages 327-341.
  14. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  15. David J. Cooper, 1999. "Gaming against Managers in Incentive Systems: Experimental Results with Chinese Students and Chinese Managers," American Economic Review, American Economic Association, American Economic Association, vol. 89(4), pages 781-804, September.
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