Contracts as Reference Points

Oliver D. Hart and John Moore

No 12706, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We argue that a contract provides a reference point for a trading relationship: more precisely, for parties' feelings of entitlement. A party's ex post performance depends on whether he gets what he is entitled to relative to outcomes permitted by the contract. A party who is shortchanged shades on performance. A flexible contract allows parties to adjust their outcome to uncertainty, but causes inefficient shading. Our analysis provides a basis for long-term contracts in the absence of noncontractible investments, and elucidates why "employment" contracts, which fix wage in advance and allow the employer to choose the task, can be optimal.

JEL-codes: D23 D86 K12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-upt
Date: 2006-11
Note: CF LE LS
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Working Paper: Contracts as Reference Points (2007)
Journal Article: Contracts as Reference Points (2008)
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