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Fairness, Incentives and Contractual Incompleteness

  • Fehr, Ernst
  • Klein, Alexander
  • Schmidt, Klaus M.

We show that concerns for fairness may have dramatic consequences for the optimal provision of incentives in a moral hazard context. Incentive contracts that are optimal when there are only selfish actors become inferior when some agents are concerned with fairness. Conversely, contracts that are doomed to fail when there are only selfish actors provide powerful incentives and become superior when there are also fair-minded players. These predictions are strongly supported by the results of a series of experiments. Furthermore, our results suggest that the existence of fair actors may be an important reason why many contracts are left deliberately incomplete.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2790.

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Date of creation: May 2001
Handle: RePEc:cpr:ceprdp:2790
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  1. 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.
  2. B. Douglas Bernheim & Michael D. Whinston, 1997. "Incomplete Contracts and Strategic Ambiguity," Harvard Institute of Economic Research Working Papers 1787, Harvard - Institute of Economic Research.
  3. Armin Falk & Urs Fischbacher, 2001. "A Theory of Reciprocity," CESifo Working Paper Series 457, CESifo Group Munich.
  4. Ernst Fehr & Armin Falk, 2003. "Wage Rigidity in a Competitive Incomplete Contract Market," Labor and Demography 0305001, EconWPA.
  5. Edlin, Aaron S & Reichelstein, Stefan, 1996. "Holdups, Standard Breach Remedies, and Optimal Investment," American Economic Review, American Economic Association, vol. 86(3), pages 478-501, June.
  6. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
  7. Ilya Segal, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 57-82.
  8. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Scholarly Articles 12375014, Harvard University Department of Economics.
  9. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
  10. Ernst Fehr & Klaus M. Schmidt, "undated". "Theories of Fairness and Reciprocity - Evidence and Economic Applications," IEW - Working Papers 075, Institute for Empirical Research in Economics - University of Zurich.
  11. Gary Charness and Matthew Rabin., 2000. "Social Preferences: Some Simple Tests and a New Model," Economics Working Papers E00-283, University of California at Berkeley.
  12. Monika Schnitzer, 1994. "The Interaction of Explicit and Implicit Contracts," Discussion Paper Serie A 452, University of Bonn, Germany.
  13. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  14. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
  15. Dufwenberg, M. & Kirchsteiger, G., 1998. "A Theory of Sequential Reciprocity," Discussion Paper 1998-37, Tilburg University, Center for Economic Research.
  16. Allen, Franklin & Gale, Douglas, 1992. "Measurement Distortion and Missing Contingencies in Optimal Contracts," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 2(1), pages 1-26, January.
  17. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-480, March.
  18. Gary E Bolton & Axel Ockenfels, 1997. "A Theory of Equity, Reciprocity, and Competition," Levine's Working Paper Archive 1889, David K. Levine.
  19. Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer.
  20. 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.
  21. George Baker & Robert Gibbons & Kevin J. Murphy, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 1125-1156.
  22. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 2001. "Reciprocity as a Contract Enforcement Device," Levine's Working Paper Archive 563824000000000143, David K. Levine.
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