IDEAS home Printed from
   My bibliography  Save this article

Self Selection and market power in risk sharing contracts


  • Prasad, Kislaya
  • Salmon, Timothy C.


Although the theory of optimal contracts and the principal agent model are now well established in the literature, empirical support for this theory has been mixed at best. We use economic experiments to test contract theory and assess the empirical relevance of two possible confounding factors that may explain why the theory has not received stronger empirical support. First, parameters of interest may be biased if agents self-select into projects with differing risk profiles based on risk preferences. Second, differing levels of market power on either side of the market could shift contract terms in ways contrary to theoretical predictions. In general, we find support for classical contract theory augmented to accommodate market power and self-selection based on risk preferences. We also find evidence for a third confound in the form of the characteristics of agents not party to the transaction affecting the terms of the contract.

Suggested Citation

  • Prasad, Kislaya & Salmon, Timothy C., 2013. "Self Selection and market power in risk sharing contracts," Journal of Economic Behavior & Organization, Elsevier, vol. 90(C), pages 71-86.
  • Handle: RePEc:eee:jeborg:v:90:y:2013:i:c:p:71-86
    DOI: 10.1016/j.jebo.2013.03.007

    Download full text from publisher

    File URL:
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    1. Fehr, Ernst & Falk, Armin, 2002. "Psychological foundations of incentives," European Economic Review, Elsevier, vol. 46(4-5), pages 687-724, May.
    2. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, January.
    3. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 1997. "Reciprocity as a Contract Enforcement Device: Experimental Evidence," Econometrica, Econometric Society, vol. 65(4), pages 833-860, July.
    4. Daniel A. Ackerberg & Maristella Botticini, 2002. "Endogenous Matching and the Empirical Determinants of Contract Form," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 564-591, June.
    5. Radosveta Ivanova-Stenzel & Timothy C. Salmon, 2004. "Bidder Preferences among Auction Institutions," Economic Inquiry, Western Economic Association International, vol. 42(2), pages 223-236, April.
    6. Gächter, Simon & Kessler, Esther & Königstein, Manfred, 2011. "The Roles of Incentives and Voluntary Cooperation for Contractual Compliance," IZA Discussion Papers 5774, Institute for the Study of Labor (IZA).
    7. Vernon L. Smith, 1962. "An Experimental Study of Competitive Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 70, pages 322-322.
    8. Jordi Brandts & Gary Charness, 2004. "Do Labour Market Conditions Affect Gift Exchange? Some Experimental Evidence," Economic Journal, Royal Economic Society, vol. 114(497), pages 684-708, July.
    9. Holt, Charles A & Langan, Loren W & Villamil, Anne P, 1986. "Market Power in Oral Double Auctions," Economic Inquiry, Western Economic Association International, vol. 24(1), pages 107-123, January.
    10. Charles A. Holt & Susan K. Laury, 2002. "Risk Aversion and Incentive Effects," American Economic Review, American Economic Association, vol. 92(5), pages 1644-1655, December.
    11. 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.
    12. Irlenbusch, Bernd & Sliwka, Dirk, 2005. "Transparency and reciprocal behavior in employment relations," Journal of Economic Behavior & Organization, Elsevier, vol. 56(3), pages 383-403, March.
    13. Sarah Jacobson & Ragan Petrie, 2007. "Inconsistent Choices in Lottery Experiments: Evidence from Rwanda," Experimental Economics Center Working Paper Series 2007-03, Experimental Economics Center, Andrew Young School of Policy Studies, Georgia State University.
    14. Radosveta Ivanova-Stenzel & Timothy C. Salmon, 2008. "Robustness Of Bidder Preferences Among Auction Institutions," Economic Inquiry, Western Economic Association International, vol. 46(3), pages 355-368, July.
    15. 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.
    16. Konigstein, Manfred & Kovacs, Judit & Zala-Mezo, Eniko, 2003. "Fairness in a one-principal-two-agents game - a post-experimental questionnaire analysis," Journal of Economic Psychology, Elsevier, vol. 24(4), pages 491-503, August.
    17. Roth, Alvin E. & Vesna Prasnikar & Masahiro Okuno-Fujiwara & Shmuel Zamir, 1991. "Bargaining and Market Behavior in Jerusalem, Ljubljana, Pittsburgh, and Tokyo: An Experimental Study," American Economic Review, American Economic Association, vol. 81(5), pages 1068-1095, December.
    18. David J. Cooper, 1999. "Gaming against Managers in Incentive Systems: Experimental Results with Chinese Students and Chinese Managers," American Economic Review, American Economic Association, vol. 89(4), pages 781-804, September.
    19. Uri Gneezy & Aldo Rustichini, 2000. "Pay Enough or Don't Pay at All," The Quarterly Journal of Economics, Oxford University Press, vol. 115(3), pages 791-810.
    20. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
    21. Canice Prendergast, 2002. "The Tenuous Trade-off between Risk and Incentives," Journal of Political Economy, University of Chicago Press, vol. 110(5), pages 1071-1102, October.
    22. Werner Güth & Wolfgang Klose & Manfred Königstein & Joachim Schwalbach, 1998. "An experimental study of a dynamic principal-agent relationship," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 19(4-5), pages 327-341.
    23. Werner Güth & Manfred Königstein & Judit Kovács & Enikõ Zala-Mezõ, 2001. "Fairness Within Firms: The Case Of One Principal And Multiple Agents," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 53(2), pages 82-101, April.
    24. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    25. Allen, Douglas & Lueck, Dean, 1992. "Contract Choice in Modern Agriculture: Cash Rent versus Cropshare," Journal of Law and Economics, University of Chicago Press, vol. 35(2), pages 397-426, October.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Kerri Brick & Martine Visser & Justine Burns, 2012. "Risk Aversion: Experimental Evidence from South African Fishing Communities," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 94(1), pages 133-152.
    2. Sarah Jacobson & Ragan Petrie, 2009. "Learning from mistakes: What do inconsistent choices over risk tell us?," Journal of Risk and Uncertainty, Springer, vol. 38(2), pages 143-158, April.
    3. Bauermeister, Golo-Friedrich & Mußhoff, Oliver, 2017. "Multiple switching behavior in different display formats of multiple price lists," DARE Discussion Papers 1706, Georg-August University of Göttingen, Department of Agricultural Economics and Rural Development (DARE).
    4. Hernán Bejarano & Francisco Galarza, 2016. "Can cognitive skills and risk aversion explain inconsistent choices? An experiment," Working Papers 16-03, Centro de Investigación, Universidad del Pacífico.

    More about this item


    Incentive contracts; Principal–agent model; Self-selection; Market power; Experiments;

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jeborg:v:90:y:2013:i:c:p:71-86. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.