Contracts, Fairness, and Incentives

Ernst Fehr, Alexander Klein and Klaus Schmidt ()

Discussion Papers in Economics from University of Munich, Department of Economics

Abstract: We show experimentally that fairness concerns may have a decisive impact on both the actual and the optimal choice of contracts in a moral hazard context. Explicit incentive contracts that are optimal according to self-interest theory become inferior when some agents value fairness. Conversely, implicit bonus contracts that are doomed to fail among purely selfish actors provide powerful incentives and become superior when there are some fair-minded players. The principals understand this and predominantly choose the bonus contracts, even preferring a pure bonus contract over a contract that combines the enforcement power of explicit and implicit incentives. This contract preference is associated with the fact that explicit incentives weaken the enforcement power of implicit bonus incentives significantly. Our results are largely consistent with recently developed theories of fairness, which also offer interesting new insights into the interaction of contract choices, fairness and incentives.

Keywords: Moral Hazard; Incentives; Bonus Contract; Fairness; Inequity Aversion (search for similar items in EconPapers)
JEL-codes: C7 C9 J3 (search for similar items in EconPapers)
Date: 2004-04
New Economics Papers: this item is included in nep-cbe and nep-ltv
References: Add references at CitEc
Citations: View citations in EconPapers (17)

Downloads: (external link)
https://epub.ub.uni-muenchen.de/334/1/Contracts_Fairness_and_Incentives.pdf (application/pdf)

Related works:
Working Paper: Contracts, Fairness and Incentives (2005)
Working Paper: Contracts, Fairness, and Incentives (2004)
Working Paper: Contracts, Fairness and Incentives (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:lmu:muenec:334

Access Statistics for this paper

More papers in Discussion Papers in Economics from University of Munich, Department of Economics Ludwigstr. 28, 80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Tamilla Benkelberg ().