Contracts as Reference Points: Experimental Evidence

41 Pages Posted: 22 Dec 2008

See all articles by Ernst Fehr

Ernst Fehr

University of Zurich - Department of Economics

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Christian Zehnder

University of Lausanne

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Abstract

In a recent paper, Hart and Moore (2008) introduce new behavioral assumptions that can explain long term contracts and important aspects of the employment relation. However, so far there exists no direct evidence that supports these assumptions and, in particular, Hart and Moore's notion that contracts provide reference points. In this paper, we examine experimentally the behavioral forces stipulated in their theory. The evidence confirms the model's prediction that there is a tradeoff between rigidity and flexibility in a trading environment with incomplete contracts and ex ante uncertainty about the state of nature. Flexible contracts - which would dominate rigid contracts under standard assumptions - cause a significant amount of shading on ex post performance while under rigid contracts much less shading occurs. Thus, although rigid contracts rule out trading in some states of the world, parties frequently implement them. While our results are broadly consistent with established behavioral concepts, they cannot easily be explained by existing theories. The experiment appears to reveal a new behavioral force: ex ante competition legitimizes the terms of a contract, and aggrievement and shading occur mainly about outcomes within the contract.

Keywords: contracts, reference points, experiment

JEL Classification: C7, D00, D2, D8, K00

Suggested Citation

Fehr, Ernst and Hart, Oliver D. and Zehnder, Christian, Contracts as Reference Points: Experimental Evidence. IZA Discussion Paper No. 3889. Available at SSRN: https://ssrn.com/abstract=1318848

Ernst Fehr (Contact Author)

University of Zurich - Department of Economics ( email )

Blümlisalpstrasse 10
Zuerich, 8006
Switzerland
+41 1 634 3709 (Phone)
+41 1 634 4907 (Fax)

Oliver D. Hart

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-496-3461 (Phone)
617-495-7730 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Christian Zehnder

University of Lausanne ( email )

Quartier Chambronne
Lausanne, Vaud CH-1015
Switzerland

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