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Fairness, Incentives and Contractual Incompleteness

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Author Info
Ernst Fehr ()
Alexander Klein
Klaus Schmidt ()

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Abstract

We show that concerns for fairness may have dramatic consequences for the optimal provision of incentives in a moral hazard context. Incentive contracts that are optimal when there are only selfish actors become inferior when some agents are concerned about fairness. Conversely, contracts that are doomed to fail when there are only selfish actors provide powerful incentives and become superior when there are also fair-minded players. These predictions are strongly supported by the results of a series of experiments. Furthermore, our results suggest that the existence of fair actors may be an important reason why many contracts are left deliberately incomplete.

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Paper provided by CESifo GmbH in its series CESifo Working Paper Series with number CESifo Working Paper No. 445.

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Date of creation: 2001
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Handle: RePEc:ces:ceswps:_445

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Related research
Keywords: Incentive contracts moral hazard fairness reciprocity incomplete contracts

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Find related papers by JEL classification:
C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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  3. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 2001. "Reciprocity as a Contract Enforcement Device," Levine's Working Paper Archive 563824000000000143, UCLA Department of Economics. [Downloadable!]
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  20. Ernst Fehr & Armin Falk, 1999. "Wage Rigidity in a Competitive Incomplete Contract Market," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 106-134, February. [Downloadable!] (restricted)
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  34. Edlin, Aaron S & Reichelstein, Stefan, 1996. "Holdups, Standard Breach Remedies, and Optimal Investment," American Economic Review, American Economic Association, vol. 86(3), pages 478-501, June. [Downloadable!] (restricted)
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