Optimal contracts, adverse selection and social preferences: An experiment

Antonio Cabrales and Gary Charness

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: It has long been standard in agency theory to search for incentive-compatible mechanisms on the assumption that people care only about their own material wealth. However, this assumption is clearly refuted by numerous experiments, and we feel that it may be useful to consider nonpecuniary utility in mechanism design and contract theory. Accordingly, we devise an experiment to explore optimal contracts in an adverse-selection context. A principal proposes one of three contract menus, each of which offers a choice of two incentive-compatible contracts, to two agents whose types are unknown to the principal. The agents know the set of possible menus, and choose to either accept one of the two contracts offered in the proposed menu or to reject the menu altogether; a rejection by either agent leads to lower (and equal) reservation payoffs for all parties. While all three possible menus favor the principal, they do so to varying degrees. We observe numerous rejections of the more lopsided menus, and approach an equilibrium where one of the more equitable contract menus (which one depends on the reservation payoffs) is proposed and agents accept a contract, selecting actions according to their types. Behavior is largely consistent with all recent models of social preferences, strongly suggesting there is value in considering nonpecuniary utility in agency theory.

Keywords: Adverse selection; contract theory; experiment; principal-agent problem; Leex (search for similar items in EconPapers)
JEL-codes: A13 B49 C91 C92 D21 J41 (search for similar items in EconPapers)
Date: 2000-06
New Economics Papers: this item is included in nep-cdm, nep-fin and nep-ind
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

Downloads: (external link)
https://econ-papers.upf.edu/papers/478.pdf Whole Paper (application/pdf)

Related works:
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:upf:upfgen:478

Access Statistics for this paper

More papers in Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra
Bibliographic data for series maintained by ( this e-mail address is bad, please contact ).