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Contracts as reference points – experimental evidence

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  • Ernst Fehr
  • Oliver Hart
  • Christian Zehnder

Abstract

In a recent paper, Hart and Moore (2008) introduce new behavioral assumptions that can explain long term contracts and important aspects of the employment relation. However, so far there exists no direct evidence that supports these assumptions and, in particular, Hart and Moore’s notion that contracts provide reference points. In this paper, we examine experimentally the behavioral forces stipulated in their theory. The evidence confirms the model’s prediction that there is a tradeoff between rigidity and flexibility in a trading environment with incomplete contracts and ex ante uncertainty about the state of nature. Flexible contracts – which would dominate rigid contracts under standard assumptions – cause a significant amount of shading on ex post performance while under rigid contracts much less shading occurs. Thus, although rigid contracts rule out trading in some states of the world, parties frequently implement them. While our results are broadly consistent with established behavioral concepts, they cannot easily be explained by existing theories. The experiment appears to reveal a new behavioral force: ex ante competition legitimizes the terms of a contract, and aggrievement and shading occur mainly about outcomes within the contract.

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Bibliographic Info

Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 393.

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Date of creation: Nov 2008
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Handle: RePEc:zur:iewwpx:393

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Keywords: Contracts; Reference Points; Experiment;

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  1. Linda Babcock & George Loewenstein, 1997. "Explaining Bargaining Impasse: The Role of Self-Serving Biases," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 109-126, Winter.
  2. Oliver Hart & John Moore, 1988. "Property Rights and the Nature of the Firm," Working papers 495, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Armin Falk & Ernst Fehr & Urs Fischbacher, 2003. "On the Nature of Fair Behavior," Economic Inquiry, Western Economic Association International, vol. 41(1), pages 20-26, January.
  4. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity," Discussion Papers in Economics 14, University of Munich, Department of Economics.
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  14. Ernst Fehr & Oliver Hart & Christian Zehnder, 2008. "Contracts as reference points – experimental evidence," IEW - Working Papers 393, Institute for Empirical Research in Economics - University of Zurich.
  15. Oliver Hart & John Moore, 2006. "Contracts as Reference Points," NBER Working Papers 12706, National Bureau of Economic Research, Inc.
  16. Grossman, Sanford J. & Hart, Oliver D., 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Scholarly Articles 3450060, Harvard University Department of Economics.
  17. Rabin, Matthew, 1993. "Incorporating Fairness into Game Theory and Economics," American Economic Review, American Economic Association, vol. 83(5), pages 1281-1302, December.
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