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Contracts and Inequity Aversion

  • Englmaier, Florian

    (University College London)

  • Achim Wambach

Inequity aversion is a special form of other regarding preferences and captures many features of reciprocal behavior, an apparently robust pattern in human nature. Using this concept we analyze the Moral Hazard problem and derive several results which differ from conventional contract theory. Our three key insights are: First, inequity aversion plays a crucial role in the design of optimal contracts. Second, there is a strong tendency towards linear sharing rules, giving a simple and plausible rationale for the prevalence of these schemes in the real world. Third, the Sufficient Statistics result no longer holds as optimal contracts may be ''too'' complete. Along with these key insights we derive a couple of further results.

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Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2003 with number 74.

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Date of creation: 04 Jun 2003
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Handle: RePEc:ecj:ac2003:74
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  1. Akerlof, George A, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, MIT Press, vol. 97(4), pages 543-69, November.
  2. H. Peyton Young & Mary A. Burke, 2001. "Competition and Custom in Economic Contracts: A Case Study of Illinois Agriculture," American Economic Review, American Economic Association, vol. 91(3), pages 559-573, June.
  3. Selten, Reinhard, . "Features of Experimentally Observed Bounded Rationality," Discussion Paper Serie B 421, University of Bonn, Germany, revised Nov 1997.
  4. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
  5. Fehr, Ernst & Schmidt, Klaus M., . "A theory of fairness, competition, and cooperation," Chapters in Economics, University of Munich, Department of Economics.
  6. Mirrlees, J A, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 3-21, January.
  7. 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.
  8. Ernst Fehr & Armin Falk, 2003. "Wage Rigidity in a Competitive Incomplete Contract Market," Labor and Demography 0305001, EconWPA.
  9. H. Peyton Young, 1996. "The Economics of Convention," Journal of Economic Perspectives, American Economic Association, vol. 10(2), pages 105-122, Spring.
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