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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
Date of revision:
Handle: RePEc:cpr:ceprdp:2790
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  1. Ernst Fehr & Armin Falk, 1999. "Wage Rigidity in a Competitive Incomplete Contract Market," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 106-134, February.
  2. Nöldeke, Georg & Schmidt, Klaus M., 1995. "Option contracts and renegotiation: A solution to the Hold-Up Problem," Munich Reprints in Economics 19329, University of Munich, Department of Economics.
  3. 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.
  4. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-80, March.
  5. Schmidt, Klaus M. & Schnitzer, Monika, 1995. "The interaction of explicit and implicit contracts," Economics Letters, Elsevier, vol. 48(2), pages 193-199, May.
  6. 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.
  7. Fehr, Ernst & Schmidt, Klaus M., . "A theory of fairness, competition, and cooperation," Chapters in Economics, University of Munich, Department of Economics.
  8. Gary Charness & Matthew Rabin, 2000. "Social Preferences: Some Simple Tests and a New Model," Econometric Society World Congress 2000 Contributed Papers 1483, Econometric Society.
  9. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity - Evidence and Economic Applications," CEPR Discussion Papers 2703, C.E.P.R. Discussion Papers.
  10. Aghion, Philippe & Dewatripont, Mathias & Rey, Patrick, 1994. "Renegotiation Design with Unverifiable Information," Econometrica, Econometric Society, vol. 62(2), pages 257-82, March.
  11. repec:oup:restud:v:66:y:1999:i:1:p:57-82 is not listed on IDEAS
  12. Bernheim, B Douglas & Whinston, Michael D, 1998. "Incomplete Contracts and Strategic Ambiguity," American Economic Review, American Economic Association, vol. 88(4), pages 902-32, September.
  13. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers 92-199, University of California at Berkeley.
  14. Allen, Franklin & Gale, Douglas, 1992. "Measurement Distortion and Missing Contingencies in Optimal Contracts," Economic Theory, Springer, vol. 2(1), pages 1-26, January.
  15. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  16. 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.
  17. Falk, Armin & Fischbacher, Urs, 2001. "A Theory of Reciprocity," CEPR Discussion Papers 3014, C.E.P.R. Discussion Papers.
  18. repec:tpr:qjecon:v:114:y:1999:i:3:p:817-868 is not listed on IDEAS
  19. Georg Kirchsteiger & Martin Dufwenberg, 2004. "A theory of sequential reciprocity," ULB Institutional Repository 2013/5899, ULB -- Universite Libre de Bruxelles.
  20. repec:oup:restud:v:66:y:1999:i:1:p:115-38 is not listed on IDEAS
  21. Gary E Bolton & Axel Ockenfels, 1997. "A Theory of Equity, Reciprocity, and Competition," Levine's Working Paper Archive 1889, David K. Levine.
  22. repec:oup:qjecon:v:114:y:1999:i:3:p:817-868 is not listed on IDEAS
  23. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 2001. "Reciprocity as a Contract Enforcement Device," Levine's Working Paper Archive 563824000000000143, David K. Levine.
  24. repec:oup:qjecon:v:109:y:1994:i:4:p:1125-56 is not listed on IDEAS
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