Fairness and Contract Design

Ernst Fehr (), Alexander Klein and Klaus M. Schmidt ()
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Alexander Klein: Department of Economics, University of Munich, Ludwigstrasse 28, D-80539 Muenchen, Germany

No 67, Discussion Papers from SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich

Abstract: 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 upfront are less efficient than incentive contracts. The principals understand this and predominantly choose the bonus contracts. Our results are consistent with recently developed theories of fairness, which offer important new insights into the interaction of contract choices, fairness and incentives.

Keywords: Moral Hazard; Incentives; Bonus Contract; Trust Contract; Fairness; Inequity Aversion (search for similar items in EconPapers)
JEL-codes: C7 C9 J3 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cbe, nep-exp, nep-gth and nep-soc
Date: 2005-11
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Related works:
Journal Article: Fairness and Contract Design (2007)
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