Stretch It but Don't Break It: The Hidden Cost of Contract Framing

Richard W. Brooks, Alexander Stremitzer and Stephan Tontrup

EconStor Preprints from ZBW - Leibniz Information Centre for Economics

Abstract: Recent research suggests that loss-framed contracts are an effective instrument for principals to maximize the effort of their agents. Framing effects arise from defining quantity and quality thresholds that vary the salience of losses and gains even while preserving the payoff equivalence of the underlying contract. While plausible interpre- tations of Prospect theory's loss-aversion insight suggest that a loss frame would lead to more effort, we show that contract thresholds also exert a norm-framing effect on performance that can trump the impact of loss aversion. Loss framing therefore carries a risk: poorly selected thresholds may reduce effort. Principals may prefer to avoid this risk by offering contracts that impose no threshold at all.

Keywords: Loss-Framing; Contract design; Signal of Performance Expectations; Reduction of Performance (search for similar items in EconPapers)
JEL-codes: C91 D02 J33 K12 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:esprep:335575

DOI: 10.2139/ssrn.2353733

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