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Contracts as Reference Points

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  • Oliver Hart
  • John Moore

Abstract

We argue that a contract provides a reference point for a trading relationship: more precisely, for parties' feelings of entitlement. A party's ex post performance depends on whether he gets what he is entitled to relative to outcomes permitted by the contract. A party who is shortchanged shades on performance. A flexible contract allows parties to adjust their outcomes to uncertainty but causes inefficient shading. Our analysis provides a basis for long-term contracts in the absence of noncontractible investments and elucidates why "employment" contracts, which fix wages in advance and allow the employer to choose the task, can be optimal.

Suggested Citation

  • Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
  • Handle: RePEc:oup:qjecon:v:123:y:2008:i:1:p:1-48.
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    File URL: http://hdl.handle.net/10.1162/qjec.2008.123.1.1
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    More about this item

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law

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