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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. Falk, Armin & Fischbacher, Urs, 2001. "A Theory of Reciprocity," CEPR Discussion Papers 3014, C.E.P.R. Discussion Papers.
  2. Oliver Hart & John Moore, 1988. "Property Rights and the Nature of the Firm," Working papers 495, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Fehr, Ernst & Hart, Oliver & Zehnder, Christian, 2008. "Contracts as Reference Points: Experimental Evidence," IZA Discussion Papers 3889, Institute for the Study of Labor (IZA).
  4. M. Rabin, 2001. "Incorporating Fairness into Game Theory and Economics," Levine's Working Paper Archive 511, David K. Levine.
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  10. 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.
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  16. Gary Charness & Matthew Rabin, 2003. "Understanding Social Preferences with Simple Tests," General Economics and Teaching 0303002, EconWPA.
  17. Fehr, Ernst & Schmidt, Klaus M., 2001. "Theories of Fairness and Reciprocity," Discussion Papers in Economics 14, University of Munich, Department of Economics.
  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.
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