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Contracts as Reference Points

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  • Oliver Hart
  • John Moore

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Abstract

We argue that a contract provides a reference point for a trading relationship: more precisely, for parties’ feelings of entitlement. A party’s ex post performance depends on whether he gets what he is entitled to relative to outcomes permitted by the contract. A party who is shortchanged shades on performance. A flexible contract allows parties to adjust their outcome to uncertainty, but causes inefficient shading. Our analysis provides a basis for long-term contracts in the absence of noncontractible investments, and elucidates why “employment” contracts, which fix wage in advance and allow the employer to choose the task, can be optimal.

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Bibliographic Info

Paper provided by Edinburgh School of Economics, University of Edinburgh in its series ESE Discussion Papers with number 170.

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Length: 70
Date of creation: 20 Sep 2007
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Handle: RePEc:edn:esedps:170

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