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

48 Pages Posted: 13 Nov 2013 Last revised: 9 Jan 2018

Richard R. W. Brooks

Columbia Law School; Yale University - Law School

Alexander Stremitzer

ETH Zurich

Stephan Tontrup

New York University School of Law

Date Written: September 1, 2017

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 thresholds that vary the salience of losses and gains while preserving payoff equivalence of the underlying contract. While under Prospect Theory a loss frame should lead to more effort we show that contract thresholds also exert a suggestive effect on performance that can trump the impact of loss aversion. Loss framing therefore carries a risk. As agents focus their effort choice on the expressed thresholds, poorly selected thresholds reduce effort and the principal might prefer offering a contract that does not impose a threshold at all. On the other hand, imposing demanding thresholds may push effort beyond levels predicted by Prospect Theory.

Keywords: contracts, framing effects, loss aversion, prospect theory, expressed thresholds, worker productivity

JEL Classification: C91, D02, J33, K12

Suggested Citation

Brooks, Richard R. W. and Stremitzer, Alexander and Tontrup, Stephan, Stretch It But Don't Break It: The Hidden Cost of Contract Framing (September 1, 2017). 46 Journal of Legal Studies 399-426 (2017); UCLA and NYU School of Law, Law-Econ Research Paper No. 13-22. Available at SSRN: https://ssrn.com/abstract=2353733 or http://dx.doi.org/10.2139/ssrn.2353733

Richard R. W. Brooks

Columbia Law School

435 West 116th Street
New York, NY 10009

Yale University - Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States

Alexander Stremitzer (Contact Author)

ETH Zurich ( email )

Haldeneggsteig 4
Zurich, 8092
Switzerland
+41 (44) 632 40 08 (Phone)

HOME PAGE: http://www.lawecon.ethz.ch/people/stremitzer.html

Stephan Tontrup

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
+1. 917 535 1165 (Phone)

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