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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. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity," Discussion Papers in Economics 14, University of Munich, Department of Economics.
  2. Oliver Hart & John Moore, 2006. "Contracts as Reference Points," NBER Working Papers 12706, National Bureau of Economic Research, Inc.
  3. Ernst Fehr & Klaus M. Schmidt, 1999. "A Theory Of Fairness, Competition, And Cooperation," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 817-868, August.
  4. Charness, Gary & Rabin, Matthew, 2002. "Understanding Social Preferences with Simple Tests," Department of Economics, Working Paper Series qt3d04q5sm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  5. Dufwenberg, Martin & Kirchsteiger, Georg, 2004. "A theory of sequential reciprocity," Games and Economic Behavior, Elsevier, vol. 47(2), pages 268-298, May.
  6. Ernst Fehr & Oliver Hart & Christian Zehnder, 2011. "Contracts as Reference Points--Experimental Evidence," American Economic Review, American Economic Association, vol. 101(2), pages 493-525, April.
  7. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Falk, Armin & Fischbacher, Urs, 2006. "A theory of reciprocity," Games and Economic Behavior, Elsevier, vol. 54(2), pages 293-315, February.
  9. Armin Falk & Ernst Fehr & Urs Fischbacher, 2003. "On the Nature of Fair Behavior," Economic Inquiry, Western Economic Association International, vol. 41(1), pages 20-26, January.
  10. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  11. 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.
  12. 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.
  13. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  14. Greiner, Ben, 2004. "An Online Recruitment System for Economic Experiments," MPRA Paper 13513, University Library of Munich, Germany.
  15. Fehr, Ernst & Kirchsteiger, George & Riedl, Arno, 1993. "Does Fairness Prevent Market Clearing? An Experimental Investigation," The Quarterly Journal of Economics, MIT Press, vol. 108(2), pages 437-59, May.
  16. Lucas C. Coffman, 2011. "Intermediation Reduces Punishment (and Reward)," American Economic Journal: Microeconomics, American Economic Association, vol. 3(4), pages 77-106, November.
  17. 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.
  18. 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.
  19. 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.
  20. Rabin, Matthew, 1993. "Incorporating Fairness into Game Theory and Economics," American Economic Review, American Economic Association, vol. 83(5), pages 1281-1302, December.
  21. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
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