Use and Abuse of Authority: A Behavioral Foundation of the Employment Relation

37 Pages Posted: 16 Nov 2012 Last revised: 19 Nov 2012

Björn Bartling

University of Zurich - Department of Economics; Norwegian School of Economics (NHH) - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Ernst Fehr

University of Zurich - Department of Economics

Klaus M. Schmidt

Ludwig Maximilian University of Munich - Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

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Date Written: November 14, 2012

Abstract

Employment contracts give a principal the authority to decide flexibly which task his agent should execute. However, there is a tradeoff, first pointed out by Simon (1951), between flexibility and employer moral hazard. An employment contract allows the principal to adjust the task quickly to the realization of the state of the world, but he may also abuse this flexibility to exploit the agent. We capture this tradeoff in an experimental design and show that principals exhibit a strong preference for the employment contract. However, selfish principals exploit agents in one-shot interactions, inducing them to resist entering into employment contracts. This resistance to employment contracts vanishes if fairness preferences in combination with reputation opportunities keep principals from abusing their power, leading to the widespread, endogenous formation of efficient long-run employment relations. Our results inform the theory of the firm by showing how behavioral forces shape an important transaction cost of integration – the abuse of authority – and by providing an empirical basis for assessing differences between the Marxian and the Coasian view of the firm, as well as Alchian and Demsetz’s (1972) critique of the Coasian approach.

Keywords: theory of the firm, transaction cost economics, authority, power abuse, employment relation, fairness, reputation

JEL Classification: C91, D23, D86, M5

Suggested Citation

Bartling, Björn and Fehr, Ernst and Schmidt, Klaus M., Use and Abuse of Authority: A Behavioral Foundation of the Employment Relation (November 14, 2012). Available at SSRN: https://ssrn.com/abstract=2175701 or http://dx.doi.org/10.2139/ssrn.2175701

Björn Bartling

University of Zurich - Department of Economics ( email )

Zuerich, 8006
Switzerland

Norwegian School of Economics (NHH) - Department of Economics ( email )

Helleveien 30
N-5035 Bergen
Norway

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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)

Klaus M. Schmidt

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Ludwig Maximilian University of Munich - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany
+49 89 2180 3405 (Phone)
+49 89 2180 3510 (Fax)

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