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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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  1. Bartling, Björn & Siemens, Ferdinand von, 2006. "The Intensity of Incentives in Firms and Markets: Moral Hazard with Envious Agents," Discussion Papers in Economics, University of Munich, Department of Economics 913, University of Munich, Department of Economics.
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  3. Grund, Christian & Sliwka, Dirk, 2002. "Envy and Compassion in Tournaments," IZA Discussion Papers 647, Institute for the Study of Labor (IZA).
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  8. Alesina, Alberto F & Di Tella, Rafael & MacCulloch, Robert, 2001. "Inequality and Happiness: Are Europeans and Americans Different?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2877, C.E.P.R. Discussion Papers.
  9. 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, Cambridge University Press, vol. 63(03), pages 625-665, September.
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  12. Axel Ockenfels & Gary E. Bolton, 2000. "ERC: A Theory of Equity, Reciprocity, and Competition," American Economic Review, American Economic Association, American Economic Association, vol. 90(1), pages 166-193, March.
  13. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournaments," Cahiers de recherche, CIRPEE 0322, CIRPEE.
  14. Holmstrom, Bengt & Milgrom, Paul, 1994. "The Firm as an Incentive System," American Economic Review, American Economic Association, American Economic Association, vol. 84(4), pages 972-91, September.
  15. M. Rabin, 2001. "Incorporating Fairness into Game Theory and Economics," Levine's Working Paper Archive 511, David K. Levine.
  16. Holmstrom, Bengt, 1981. "Contractual Models of the Labor Market," American Economic Review, American Economic Association, American Economic Association, vol. 71(2), pages 308-13, May.
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