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Use and Abuse of Authority: A Behavioral Foundation of the Employment Relation

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  • Bartling, Björn

    ()
    (University of Zurich)

  • Fehr, Ernst

    ()
    (University of Zurich)

  • Schmidt, Klaus M.

    ()
    (University of Munich)

Abstract

Employment contracts give a principal the authority to decide flexibly which task his agent should execute. However, there is a tradeoff, first pointed out by Simon (1951), between flexibility and employer moral hazard. An employment contract allows the principal to adjust the task quickly to the realization of the state of the world, but he may also abuse this flexibility to exploit the agent. We capture this tradeoff in an experimental design and show that principals exhibit a strong preference for the employment contract. However, selfish principals exploit agents in one-shot interactions, inducing them to resist entering into employment contracts. This resistance to employment contracts vanishes if fairness preferences in combination with reputation opportunities keep principals from abusing their power, leading to the widespread, endogenous formation of efficient long-run employment relations. Our results inform the theory of the firm by showing how behavioral forces shape an important transaction cost of integration – the abuse of authority – and by providing an empirical basis for assessing differences between the Marxian and the Coasian view of the firm, as well as Alchian and Demsetz's (1972) critique of the Coasian approach.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 7029.

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Length: 39 pages
Date of creation: Nov 2012
Date of revision:
Handle: RePEc:iza:izadps:dp7029

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Keywords: theory of the firm; transaction cost economics; authority; power abuse; employment relation; fairness; reputation;

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  1. Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, MIT Press, vol. 123(1), pages 1-48, 02.
  2. Björn Bartling & Klaus M. Schmidt, 2012. "Reference points in renegotiations: The role of contracts and competition," ECON - Working Papers 089, Department of Economics - University of Zurich.
  3. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
  4. Ernst Fehr & Oliver D. Hart & Christian Zehnder, 2008. "Contracts as Reference Points - Experimental Evidence," NBER Working Papers 14501, National Bureau of Economic Research, Inc.
  5. Robert Gibbons, 2010. "Transaction-Cost Economics: Past, Present, and Future?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 112(2), pages 263-288, 06.
  6. Masten, Scott E, 1984. "The Organization of Production: Evidence from the Aerospace Industry," Journal of Law and Economics, University of Chicago Press, vol. 27(2), pages 403-17, October.
  7. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
  8. Brown, Martin & Falk, Armin & Fehr, Ernst, 2011. "Competition and Relational Contracts: The Role of Unemployment as a Disciplinary Device," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 359, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  9. Stefan Grosse & Louis Putterman & Bettina Rockenbach, 2011. "Monitoring In Teams: Using Laboratory Experiments To Study A Theory Of The Firm," Journal of the European Economic Association, European Economic Association, vol. 9(4), pages 785-816, 08.
  10. Bartling, Björn & Schmidt, Klaus M., 2012. "Reference Points in Renegotiations: The Role of Contracts and Competition," Discussion Papers in Economics 14192, University of Munich, Department of Economics.
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Cited by:
  1. Carpenter, Jeffrey P. & Dolifka, David, 2013. "Exploitation Aversion: When Financial Incentives Fail to Motivate Agents," IZA Discussion Papers 7499, Institute for the Study of Labor (IZA).

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