Contracts as Reference Points

Oliver Hart and John Moore

The Quarterly Journal of Economics, 2008, vol. 123, issue 1, 1-48

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 outcomes 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 wages in advance and allow the employer to choose the task, can be optimal.

Date: 2008
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Working Paper: Contracts as Reference Points (2006)
Working Paper: Contracts as Reference Points (2006)
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