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Abstract:
We show that concerns for fairness may have dramatic consequences for the optimal provision of incentives in a moral hazard context. Incentive contracts that are optimal when there are only selfish actors become inferior when some agents are concerned with fairness. Conversely, contracts that are doomed to fail when there are only selfish actors provide powerful incentives and become superior when there are also fair-minded players. These predictions are strongly supported by the results of a series of experiments. Furthermore, our results suggest that the existence of fair actors may be an important reason why many contracts are left deliberately incomplete.

Fairness, incentive contracts, incomplete contracts, moral hazard, reciprocity

Abstract:
We show that concerns for fairness may have dramatic consequences for the optimal provision of incentives in a moral hazard context. Incentive contracts that are optimal when there are only selfish actors become inferior when some agents are concerned about fairness. Conversely, contracts that are doomed to fail when there are only selfish actors provide powerful incentives and become superior when there are also fair-minded players. These predictions are strongly supported by the results of a series of experiments. Furthermore, our results suggest that the existence of fair actors may be an important reason why many contracts are left deliberately incomplete.

Incentive Contracts, Moral Hazard, Fairness, Reciprocity, Incomplete Contracts

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.

Moral hazard, incentives, bonus contract, fairness, inequity aversion

Abstract:
We reconsider two standard results of deterrence theory. The first states that there is no need for jail terms until monetary fines are not exhausted. The second says that there is no marginal deterrence without joint production in law enforcement.

In a framework with asymmetric information about offenders' wealth, however, neither result holds if one takes into account a commonly used instrument of law enforcement, namely to offer the convicted criminal the choice of either going to jail or paying a fine.

The basic idea of our paper is that the fine can be adjusted such that only one of two types prefers it over the jail term. Thus, fine-jail-options serve as a screening device because they allow to deter both types independently although their wealth is private information.