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Fairness and contract design

  • Fehr, Ernst
  • Klein, Alexander
  • Schmidt, Klaus M.

We show experimentally that fairness concerns may have a decisive impact on the actual and optimal choice of contracts in a moral hazard context. Bonus contracts that offer a voluntary and unenforceable bonus for satisfactory performance provide powerful incentives and are superior to explicit incentive contracts when there are some fair-minded players, but trust contracts that pay a generous wage up front are less efficient than incentive contracts. The principals understand this and predominantly choose the bonus contracts. These results are consistent with recently developed theories of fairness, which offer important new insights into the interaction of contract choices, fairness, and incentives.

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Paper provided by University of Munich, Department of Economics in its series Munich Reprints in Economics with number 20618.

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Date of creation: 2007
Date of revision:
Publication status: Published in Econometrica 1 75(2007): pp. 121-154
Handle: RePEc:lmu:muenar:20618
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  25. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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  29. Berg Joyce & Dickhaut John & McCabe Kevin, 1995. "Trust, Reciprocity, and Social History," Games and Economic Behavior, Elsevier, vol. 10(1), pages 122-142, July.
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