Do Incentive Contracts Crowd Out Voluntary Cooperation?

Abstract

In this paper we provide experimental evidence indicating that incentive contracts may cause a strong crowding out of reciprocity-driven voluntary cooperation. This crowding out effect constitutes costs of incentive provision that have been largely neglected by economists. In our experiments the crowding out effect is so strong that the incentive contracts are less efficient than contracts without any incentives. Principals, nonetheless, prefer the incentive contracts because they allow them to appropriate a much larger share of the (smaller) total surplus and are, hence, more profitable for them.

Keywords: Incentive contracts, reciprocity, incomplete contracts, voluntary cooperation, experiments

JEL Classification: J41, C91, D64