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Contracts as reference points � experimental evidence

Author

Listed:
  • Ernst Fehr
  • Oliver Hart
  • Christian Zehnder

Abstract

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.

Suggested Citation

  • 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.
  • Handle: RePEc:zur:iewwpx:393
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    File URL: http://www.econ.uzh.ch/static/wp_iew/iewwp393.pdf
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    References listed on IDEAS

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    1. 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.
    2. Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
    3. Ernst Fehr & Klaus M. Schmidt, 1999. "A Theory of Fairness, Competition, and Cooperation," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 817-868.
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    More about this item

    Keywords

    Contracts; Reference Points; Experiment;

    JEL classification:

    • D0 - Microeconomics - - General
    • J0 - Labor and Demographic Economics - - General
    • L0 - Industrial Organization - - General

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