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Promises in contract design

Listed author(s):
  • Charness, Gary
  • Du, Ninghua
  • Yang, Chun-Lei
  • Yao, Lan

In this paper, we propose a new channel of contract design to boost efficiency. If deviating from one's own words induces a self-imposed moral burden, the optimal contracting procedure with regard to cheap talk shall assign the responsibility for installing the nonbinding promise in the contract to whoever has the residual right to break such promise, in the spirit of Grossman and Hart (1986) and Hart and Moore (1990). To study whether a worker's own promise of effort level governs his real choice of effort in a gift exchange game, we implement four treatments in our experiments by varying two factors: (1) who (the firm or the worker) takes the position of the proposer to propose the contract and (2) whether the proposed contract includes a nonbinding specification of the worker's effort level. Our key finding is that when it is the worker who proposes the contract and the contract includes the worker's promised effort level, both the worker's actual effort choice and the aggregate profits are significantly higher than in each of the other three treatments (and there is little difference in worker effort otherwise).

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File URL: http://www.sciencedirect.com/science/article/pii/S0014292113001153
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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 64 (2013)
Issue (Month): C ()
Pages: 194-208

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Handle: RePEc:eee:eecrev:v:64:y:2013:i:c:p:194-208
DOI: 10.1016/j.euroecorev.2013.07.012
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  16. Bauernschuster, Stefan & Duersch, Peter & Oechssler, Jörg & Vadovic, Radovan, 2010. "Mandatory sick pay provision: A labor market experiment," Journal of Public Economics, Elsevier, vol. 94(11-12), pages 870-877, December.
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  30. Bracht, Juergen & Feltovich, Nick, 2009. "Whatever you say, your reputation precedes you: Observation and cheap talk in the trust game," Journal of Public Economics, Elsevier, vol. 93(9-10), pages 1036-1044, October.
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