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Contracts as Reference Points: Experimental Evidence

  • Fehr, Ernst

    ()

    (University of Zurich)

  • Hart, Oliver

    ()

    (Harvard University)

  • Zehnder, Christian

    ()

    (University of Lausanne)

In a recent paper, Hart and Moore (2008) introduce new behavioral assumptions that can explain long term contracts and important aspects of the employment relation. However, so far there exists no direct evidence that supports these assumptions and, in particular, Hart and Moore's notion that contracts provide reference points. In this paper, we examine experimentally the behavioral forces stipulated in their theory. The evidence confirms the model's prediction that there is a tradeoff between rigidity and flexibility in a trading environment with incomplete contracts and ex ante uncertainty about the state of nature. Flexible contracts – which would dominate rigid contracts under standard assumptions –cause a significant amount of shading on ex post performance while under rigid contracts much less shading occurs. Thus, although rigid contracts rule out trading in some states of the world, parties frequently implement them. While our results are broadly consistent with established behavioral concepts, they cannot easily be explained by existing theories. The experiment appears to reveal a new behavioral force: ex ante competition legitimizes the terms of a contract, and aggrievement and shading occur mainly about outcomes within the contract.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 3889.

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Length: 41 pages
Date of creation: Dec 2008
Date of revision:
Publication status: published in: American Economic Review, 2011, 101 (2), 493-525
Handle: RePEc:iza:izadps:dp3889
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  1. Rabin, Matthew, 1993. "Incorporating Fairness into Game Theory and Economics," American Economic Review, American Economic Association, vol. 83(5), pages 1281-1302, December.
  2. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  3. Dufwenberg, M. & Kirchsteiger, G., 1998. "A Theory of Sequential Reciprocity," Discussion Paper 1998-37, Tilburg University, Center for Economic Research.
  4. Armin Falk & Urs Fischbacher, . "A Theory of Reciprocity," IEW - Working Papers 006, Institute for Empirical Research in Economics - University of Zurich.
  5. Ernst Fehr & Oliver D. Hart & Christian Zehnder, 2008. "Contracts as Reference Points - Experimental Evidence," NBER Working Papers 14501, National Bureau of Economic Research, Inc.
  6. Gary Charness & Matthew Rabin, 2002. "Understanding Social Preferences with Simple Tests," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 817-869.
  7. Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
  8. Armin Falk & Ernst Fehr & Urs Fischbacher, . "On the Nature of Fair Behavior," IEW - Working Papers 017, Institute for Empirical Research in Economics - University of Zurich.
  9. Guth, Werner & Schmittberger, Rolf & Schwarze, Bernd, 1982. "An experimental analysis of ultimatum bargaining," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 367-388, December.
  10. Björn Bartling & Urs Fischbacher, 2012. "Shifting the Blame: On Delegation and Responsibility," Review of Economic Studies, Oxford University Press, vol. 79(1), pages 67-87.
  11. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  12. Fehr, Ernst & Schmidt, Klaus M., . "A theory of fairness, competition, and cooperation," Chapters in Economics, University of Munich, Department of Economics.
  13. Greiner, Ben, 2004. "An Online Recruitment System for Economic Experiments," MPRA Paper 13513, University Library of Munich, Germany.
  14. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity," Discussion Papers in Economics 14, University of Munich, Department of Economics.
  15. 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.
  16. Linda Babcock & George Loewenstein, 1997. "Explaining Bargaining Impasse: The Role of Self-Serving Biases," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 109-126, Winter.
  17. Lucas C. Coffman, 2011. "Intermediation Reduces Punishment (and Reward)," American Economic Journal: Microeconomics, American Economic Association, vol. 3(4), pages 77-106, November.
  18. Ernst Fehr & Georg Kirchsteiger & Arno Riedl, 1993. "Does Fairness Prevent Market Clearing? An Experimental Investigation," The Quarterly Journal of Economics, Oxford University Press, vol. 108(2), pages 437-459.
  19. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
  20. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  21. Colin F. Camerer & Richard H. Thaler, 1995. "Anomalies: Ultimatums, Dictators and Manners," Journal of Economic Perspectives, American Economic Association, vol. 9(2), pages 209-219, Spring.
  22. Ernst Fehr & Oliver Hart & Christian Zehnder, 2008. "Contracts as reference points � experimental evidence," IEW - Working Papers 393, Institute for Empirical Research in Economics - University of Zurich.
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