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Fairness, Incentives and Contractual Incompleteness

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  • Fehr, Ernst
  • Klein, Alexander
  • Schmidt, Klaus M.

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 with 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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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2790.

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Date of creation: May 2001
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Handle: RePEc:cpr:ceprdp:2790

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Keywords: Fairness; Incentive Contracts; Incomplete Contracts; Moral Hazard; Reciprocity;

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References

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  1. Dufwenberg, M. & Kirchsteiger, G., 1998. "A Theory of Sequential Reciprocity," Discussion Paper 1998-37, Tilburg University, Center for Economic Research.
  2. Armin Falk & Urs Fischbacher, 2001. "A Theory of Reciprocity," CESifo Working Paper Series 457, CESifo Group Munich.
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  4. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
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