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Fairness and Contract Design

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Author Info
Ernst Fehr (Institute for Empirical Research in Economics, University of Zurich, Bluemlisalpstrasse 10, CH-8006 Zurich, Switzerland, email: efehr@iew.unizh.ch and Collegium Helveticum, Schmelzbergstrasse 25, CH-8092 Zürich, Switzerland)
Alexander Klein (Department of Economics, University of Munich, Ludwigstrasse 28, D-80539 Muenchen, Germany)
Klaus M. Schmidt (Department of Economics, University of Munich, Ludwigstrasse 28, D-80539 Muenchen, Germany, email: klaus.schmidt@Lrz.uni-muenchen.de)

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Abstract

We show experimentally that fairness concerns may have a decisive impact on the actual and optimal choice of contracts in a moral hazard context. Bonus contracts that offer a voluntary and unenforceable bonus for satisfactory performance provide powerful incentives and are superior to explicit incentive contracts when there are some fair-minded players. But trust contracts that pay a generous wage upfront are less efficient than incentive contracts. The principals understand this and predominantly choose the bonus contracts. Our results are consistent with recently developed theories of fairness, which offer important new insights into the interaction of contract choices, fairness and incentives.

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Publisher Info
Paper provided by SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Papers with number 67.

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Date of creation: Nov 2005
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Handle: RePEc:trf:wpaper:67

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Related research
Keywords: Moral Hazard; Incentives; Bonus Contract; Trust Contract; Fairness; Inequity Aversion;

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Find related papers by JEL classification:
C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
C9 - Mathematical and Quantitative Methods - - Design of Experiments
J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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