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How Do Informal Agreements And Revision Shape Contractual Reference Points?

Listed author(s):
  • Ernst Fehr
  • Oliver Hart
  • Christian Zehnder

The notion of contracts as reference points provides the basis for a deeper understanding of important phenomena such as the employment contract, vertical integration, firm scope, authority, and delegation. Previous experiments lend support to this notion but they ignore realistic aspects of trading relationships such as informal agreements and ex-post renegotiation or revision. Here we show that the central behavioral mechanism underlying contractual reference points is robust to such considerations. Our data reveal that informal agreements can mitigate the trade-off between rigidity and flexibility but they do not fully resolve the problem of misaligned reference points. Our experiments also show that contract revision is a more nuanced process than the previous literature has recognized. We find, for example, that it is sometimes better for parties to write a simple (rigid) contract and then revise it ex post if needed, rather than to anticipate and include future contingencies in a (flexible) contract from the outset.

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File URL: http://hdl.handle.net/10.1111/jeea.12098
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Article provided by European Economic Association in its journal Journal of the European Economic Association.

Volume (Year): 13 (2015)
Issue (Month): 1 (February)
Pages: 1-28

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Handle: RePEc:bla:jeurec:v:13:y:2015:i:1:p:1-28
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  1. Gary Charness & Matthew Rabin, 2002. "Understanding Social Preferences with Simple Tests," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 817-869.
  2. Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
  3. Ernst Fehr & Klaus M. Schmidt, 1999. "A Theory of Fairness, Competition, and Cooperation," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 817-868.
  4. Oliver Hart & Bengt Holmstrom, 2010. "A Theory of Firm Scope," The Quarterly Journal of Economics, Oxford University Press, vol. 125(2), pages 483-513.
  5. Simon Gachter & Ernst Fehr, 2000. "Cooperation and Punishment in Public Goods Experiments," American Economic Review, American Economic Association, vol. 90(4), pages 980-994, September.
  6. 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.
  7. Ernst Fehr & Oliver Hart & Christian Zehnder, 2011. "Contracts as Reference Points--Experimental Evidence," American Economic Review, American Economic Association, vol. 101(2), pages 493-525, April.
  8. Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 39-56.
  9. Ernst Fehr & Lorenz Goette & Christian Zehnder, 2009. "A Behavioral Account of the Labor Market: The Role of Fairness Concerns," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 355-384, May.
  10. Dufwenberg, Martin & Kirchsteiger, Georg, 2004. "A theory of sequential reciprocity," Games and Economic Behavior, Elsevier, vol. 47(2), pages 268-298, May.
  11. Raghuram Rajan, 2012. "The Corporation in Finance," NBER Working Papers 17760, National Bureau of Economic Research, Inc.
  12. Klein, Benjamin, 1996. "Why Hold-Ups Occur: The Self-Enforcing Range of Contractual Relationships," Economic Inquiry, Western Economic Association International, vol. 34(3), pages 444-463, July.
  13. Hoppe, Eva I. & Schmitz, Patrick W., 2011. "Can contracts solve the hold-up problem? Experimental evidence," Games and Economic Behavior, Elsevier, vol. 73(1), pages 186-199, 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. Raghuram G. Rajan, 2012. "Presidential Address: The Corporation in Finance," Journal of Finance, American Finance Association, vol. 67(4), pages 1173-1217, 08.
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  17. Guth, Werner & Schmittberger, Rolf & Schwarze, Bernd, 1982. "An experimental analysis of ultimatum bargaining," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 367-388, December.
  18. Ernst Fehr & Oliver Hart & Christian Zehnder, 2009. "Contracts, Reference Points, and Competition-Behavioral Effects of The Fundamental Transformation," Journal of the European Economic Association, MIT Press, vol. 7(2-3), pages 561-572, 04-05.
  19. Oliver Hart, 2009. "Hold-up, Asset Ownership, and Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 124(1), pages 267-300.
  20. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
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