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Contracts as Reference Points

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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 outcome 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 wage in advance and allow the employer to choose the task, can be optimal.

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  • Oliver Hart & John Moore, 2006. "Contracts as Reference Points," Edinburgh School of Economics Discussion Paper Series 170, Edinburgh School of Economics, University of Edinburgh.
  • Handle: RePEc:edn:esedps:170
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    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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