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Relational Contracts and Inequity Aversion

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  • Jenny Kragl
  • Julia Schmid

Abstract

We study the effects of envy on the feasibility of relational contracts in a standard moral hazard setup with two agents. Performance is evaluated via an observable, but non-contractible signal which reflects the agent´s individual contribution to firm value. Both agents exhibit disadvantageous inequity aversion. In contrast to the literature, we find that inequity aversion may be beneficial: In the presence of envy, for a certain range of interest rates relational contracts may be more profitable. Furthermore, for some interest rates reputational equilibria exist only with inequity averse agents.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-085.

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Length: 23 pages
Date of creation: Dec 2006
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2006-085

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Keywords: Principal-Agent; Relational Contract; Inequity Aversion; Envy;

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  2. Fehr, Ernst & Schmidt, Klaus M., 1999. "A theory of fairness, competition, and cooperation," Munich Reprints in Economics 20650, University of Munich, Department of Economics.
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  8. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournaments," Cahiers de recherche 0322, CIRPEE.
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  10. Alberto Alesina & Rafael Di Tella & Robert MacCulloch, 2001. "Inequality and Happiness: Are Europeans and Americans Different?," Harvard Institute of Economic Research Working Papers 1938, Harvard - Institute of Economic Research.
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  13. Moriguchi, Chiaki, 2003. "Implicit Contracts, the Great Depression, and Institutional Change: A Comparative Analysis of U.S. and Japanese Employment Relations, 1920 1940," The Journal of Economic History, Cambridge University Press, vol. 63(03), pages 625-665, September.
  14. Axel Ockenfels & Gary E. Bolton, 2000. "ERC: A Theory of Equity, Reciprocity, and Competition," American Economic Review, American Economic Association, vol. 90(1), pages 166-193, March.
  15. Berg Joyce & Dickhaut John & McCabe Kevin, 1995. "Trust, Reciprocity, and Social History," Games and Economic Behavior, Elsevier, vol. 10(1), pages 122-142, July.
  16. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
  17. Holmstrom, Bengt & Milgrom, Paul, 1994. "The Firm as an Incentive System," American Economic Review, American Economic Association, vol. 84(4), pages 972-91, September.
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